CFaR in terms of currencies relates to the currency risk on already fixed payments with the worst-case scenario being the least favourable movements in the portfolio currencies.
The worst-case scenario is determined with a 95% probability. Statistically the cash flow will in 1 out of 20 instances reach a level below that of the worst-case scenario, corresponding to a 5% probability.
The strengths of CFaR are that the currency risk on payments is quantified and that the risk varying with the payment date is taken into account. Moreover, the portfolio as a whole is taken into consideration as are correlations between currencies.
The calculations are based on historical data (volatility), which may change over time, thus affecting the current risk simulation.
For each payment 10,000 cash flow simulations based on the spot rate, volatility and correlation are performed. The results of the 10,000 simulations generate a probability distribution on the basis of which CFaR is determined.
