Risk Management and Financial Controls
What this domain tests
This domain tests identification, measurement, and control of market, credit, liquidity, and operational risk in energy trading, including limit setting, margining, collateral, and independent validation.
Core rules and concepts
- Market risk: mark-to-market revaluation, volatility, correlation, and load/price covariance. Value-at-Risk (VaR) estimates a loss threshold over a horizon and confidence level, not a worst-case loss.
- Credit risk: counterparty default exposure, netting, collateral, margining, wrong-way risk, and credit limits by counterparty and tenor.
- Liquidity risk: ability to exit or fund positions; includes market liquidity and funding liquidity.
- Controls: front-office limits, independent middle-office measurement, back-office confirmation and settlement, segregation of duties, and escalation of limit breaches.
- Stress testing: scenario shocks beyond normal distributions, including price spikes, correlation breakdown, and collateral calls.
Worked example
A portfolio has a one-day 95% VaR of €300,000. A rough square-root-of-time scaling gives a 10-day VaR of €300,000 × √10 ≈ €949,000, assuming independent daily returns and unchanged positions. The statement means that under the model, losses should exceed €949,000 on about 5% of 10-day periods; it does not mean maximum loss is €949,000. A stress test might instead apply a 300% price spike and a simultaneous collateral haircut, producing a larger loss and a funding need that VaR misses.
Traps that cost marks
Treating VaR as a maximum loss; ignoring fat tails and price spikes; assuming correlations stay stable in stress; using the wrong confidence level or horizon; and relying on collateral without haircuts or wrong-way-risk analysis.