June 2007 Capital Adequacy Extension © Copyright 2007, CCRO. All rights reserved. Page 67 of 92 Figure 6.1 Earnings Distribution Generation As displayed above, the initiation of scenario generation is the market risk factor propagation process. The projected rates for market risk factors will be the driving element for creating the earnings distributions. The projected rates will impact the earnings elements vis-à-vis the relationship that was established among those elements during Exposure Mapping. There are many different ways to approach the propagation process, and most methods will utilize the volatilities and correlations that were discussed earlier in Exposure Mapping. Monte Carlo techniques are very popular for executing market rate projections, and it is important to understand this technique and how it utilizes volatilities, correlations, what the assumed distribution of the random process is, as well as other elements that are essential to the Monte Carlo modeling process. For more information regarding this and other modeling techniques, refer to the CCRO’s ‘Enterprise Risk Management and Supporting Metrics’ white paper published February 2006 and the ‘Valuation and Risk Metrics’ white paper published November 2002. Commodity Foreign Exchange Interest Rate Equity Rates E(x)=20 E(x)=23 E(x)=10 E(x)=17 Revenue Q+1 Q+2 Q+3 Q+4 Power Sales 100 93 110 90 (Fwd, Spot) Expenses Gas Purchases (80) (83) (90) (92) Interest (5) (7) (9) (11) Other Rev/Exp Hedging Activity (5) 8 (10) 15 Equity Interests 10 12 9 11 NET INCOME 20 23 10 17 (Before taxes, dep, & amort) MARKET RISK MAPPED EARNINGS BUDGETED TARGETS PROJECTIONS RELATIONSHIPS COMPONENTS PRO FORMA STATEMENTS EaR @ Q+1 EaR @ Q+2 EaR @ Q+3 EaR @ Q+4 •Forward Curves •Volatilities •Correlations •Market Views