June 2007 Capital Adequacy Extension © Copyright 2007, CCRO. All rights reserved. Page 73 of 92 Framework, which is similar to the Framework outlined in Chapter V, but recognizing those differences between cash flow and earnings. • Establish Cash Flow Expectations: Lay the foundation, or base case, from which the risks will be assessed. These will be the target values from which the “at-risk” number to those expected earnings will be determined. In establishing the “base case” cash flow expectations, the result can be a Cash Flow Statement Pro-Forma, or a similar format, that displays the cash flow expectations and the individual components that make up the expected cash flow result. • Exposure Mapping: Establish a relationship between the Market risk factors and the components that comprise cash flow. It is a twofold process that a) establishes what Market risk factor is related to what cash flow component, and b) establishes how they are related. • Scenario Generation: The range of potential values for the Market Risk factors is assessed. This can be done through Monte Carlo methods or closed form solutions, however the Market rate propagation process, based on the relationship established in Exposure Mapping, will drive the value of the components that make up cash flow. This process will result in the ‘Distribution’ of potential cash flow over a given time frame. • Stress Testing: This aspect deals with stress testing the results achieved in Scenario Generation and assessing the cash flow situation by incorporating macro economic scenarios, disaster scenarios, varying business risk factors, as well as market risk factors to gauge how the cash situation changes under various different scenarios. This process will result in potential cash flow outcomes that reside ‘Outside the Distribution’. The fundamentals of each aspect of this framework were outlined in Chapter 5, the Market Risk Chapter, and remain the fundamentals for the assessment of Cash Flow at Risk as well. Figure 8.1, like Figure 6.1 from Chapter 6, illustrates how these Framework elements are brought together to make a CFaR assessment, focusing on the Sources and Uses of Cash as opposed to the Revenue and Expenses associated with Earnings.