Emerging Practices for Capital Adequacy © Copyright 2003, CCRO. All rights reserved. 50 Fixed payments are associated with investing or financing activities included in an organization’s cash flow statements under normal day-to-day conditions. A company is required to hold contingent liquidity as a cushion to support additional demand for liquidity such as cash collateral due to market price movements or stress events. Contingent liquidity includes cash flow at risk (CFaR) and trigger or stress events. The trigger or stress events measure the need for higher liquidity requirements under financially distressed conditions. Modeling liquidity is challenging. To the extent possible, we can use the same price propagation or price modeling process used in market and credit risk assessments combined with financial relationships used in the construction of forward-looking financial cash flow statements. It is also necessary to account for conditional events such as trigger events, probability of counterparty defaults, material adverse changes, adequate assurances, and debt to equity triggers. Modeling liquidity is a complex but necessary effort in measuring liquidity adequacy. As indicated in Figure 18, the following are the basic steps for assessing liquidity: 1. Determine all sources of liquidity either internally or externally in a specified time period. 2. Determine the amount of all required fixed payments for the same time horizon. 3. Run a cash flow at risk model to determine how much cash is at risk in the worst-case scenario at a specified confidence level. 4. Measure the amount of contingent liquidity related to trigger and stress events. 5. Calculate how much liquidity is available with certainty after absorbing fixed payments, cash flow at risk, and other contingency liquidity necessary for trigger or stress events. 8.2 Sources of Liquidity Sources of liquidity encompass (1) all financial resources that are readily available, during a period, to meet fixed payments and obligations for day-to-day operations including debt repayment and (2) all sources of funding that can be used to satisfy the company’s contingent liquidity requirements over the relevant time horizon. The three major sources of liquidity are described below. 8.2.1 Cash and Cash Equivalents This is the cash balance at the beginning of a period to serve as the liquidity already available and includes a letter of credit capacity from banks. 8.2.2 Expected Cash Flow from Operations Cash from operations is defined as the expected cash to be generated from the operating activities of a company. It is added as incremental cash flow to the beginning balance of cash and cash equivalents to form the total internal liquidity sources during a forward period.