3.A Bank must specify a set of risk factors corresponding to interest rates in each currency in which the Bank has interest-rate-sensitive on- or off-balance sheet positions. The number of risk factors used must be driven by the nature of the Bank’s trading strategies and must include, at a minimum, the following:
a.Modelling of the yield curve using one of a number of generally accepted approaches, for example, by estimating forward rates of zero coupon yields.
b.Dividing the yield curve into various maturity segments in order to capture variation in the volatility of rates along the yield curve. There typically will be one risk factor corresponding to each maturity segment.
c.For material exposures to interest rate movements in the major currencies and markets, modelling the yield curve using a minimum of six risk factors. The number of risk factors used ultimately must be driven by the nature of the Bank’s trading strategies. For instance, a Bank with a portfolio of various types of securities across many points of the yield curve and that engages in complex arbitrage strategies would require a greater number of risk factors to capture interest rate risk accurately.
4.The risk measurement system must incorporate separate risk factors to capture spread risk (e.g. between bonds and swaps). These include but are not limited to specifying a completely separate yield curve for non-government fixed-income instruments (for instance, swaps or municipal securities) and estimating the spread over government rates at various points along the yield curve.