(b) Foreign Exchange. Like other large FIs, J.P. Morgan Chase actively trades in
foreign exchange (FX). Remember that:
Suppose the FI had a Swf 1.6 million trading position in spot Swiss Francs at the
close of business on a particular day. The FI wants to calculate the daily earnings at
risk from this position (i.e., the risk exposure on this position should the next day be
a “bad” day in the FX markets with respect to the value of the Swiss franc against the
dollar).
The first step is to calculate the dollar value of the position:
If the exchange rate is Swf 1.60/$1 or $0.625/Swf at the daily close, then
Suppose that, looking back at the daily changes in the Swf/$ exchange rate over
the past year, we find that the volatility or standard deviation () of daily changes in
the spot exchange rate was 56.5 bp. However, suppose that the FI is interested in ad-
verse moves—that is, bad moves that will not occur more than 5% of the time, or 1
day in every 20. Statistically speaking, if changes in exchange rates are historically
“normally” distributed, the exchange rate must change in the adverse direction by
1.65(1.65×56.5 bp) for this change to be viewed as likely to occur only 1 day in
every 20 days:^17
In other words, during the last year, the Swiss franc declined in value against the dol-
lar by 93.2 bp 5% of the time. As a result:
This is the potential daily earnings exposure to adverse Swiss franc to dollar ex-
change rate changes for the FI from the Swf 1.6 million spot currency holdings.
$9,320 1 $1 million 2 1 .00932 2DEAR 1 Dollar value of position 2 1 FX volatility 2FX volatility1.65 56.5 bp93.2 bp or 0.932%$1 millionDollar value of position 1 Swf 1.6 million 2 1 $0.625>Swf 2 1 $ per unit of foreign currency 2 1 Swf 1.6 million 2Dollar equivalent value of position 1 FX position 2 1 Swf>$ spot exchange rate 2DEAR 1 Dollar value of position 2 1 Price volatility 28.4 RISKMETRICS MODEL 8 • 9(^17) Technically, 90% of the area under a normal distribution lies between ±1.65from the mean. This
means that 5% of the time, daily exchange rate changes will increase by more than 1.65, and 5% of the
time, will decrease by 1.65. This case concerns only adverse moves in the exchange rate of Swiss francs
to dollars (i.e., a depreciation of 1.65).