Financial Risk Management:Financial Risk Management:

An Earnings-at-Risk ApproachAn Earnings-at-Risk Approach

Daniel MontanteDaniel Montante

E.I. du Pont de Nemours & CompanyE.I. du Pont de Nemours & Company

December 6, 2000December 6, 2000

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Some Company BackgroundSome Company Background

• Centralized Treasury– FX Exposure in 40+ Currencies

– $2 Billion Hedgeable Commodity Exposure

– $10+ Billion Debt Portfolio

• Notable Portfolio Changes – Conoco Divestiture

• energy subsidiary

– Pioneer Hi-Bred International Acquisition• agricultural subsidiary

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Energy Feedstock #19%

Energy Feedstock #24%

Energy Feedstock #35%

Agriculture #12%

Agriculture #22%

Anticipated Local Currency Margins

46%

Floating Rate Debt32%

Notional Amount at RiskNotional Amount at Risk= $5 billion= $5 billion

For illustrative purposes only

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DuPont's Earnings-at-Risk (EaR) ApproachDuPont's Earnings-at-Risk (EaR) ApproachOur more quantitative approach to corporate global risk Our more quantitative approach to corporate global risk

management . . .management . . .

Earnings-at-Risk (EaR)• Calculates the maximum loss on business and/or financial positions on

a probability basis based on degrees of confidence

• Basically: Revalue expected earnings with maximum potential earnings shortfall due to adverse market movements

– Monte Carlo simulation

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DuPont's Earnings-at-Risk (EaR) ApproachDuPont's Earnings-at-Risk (EaR) ApproachOur more quantitative approach to corporate global risk Our more quantitative approach to corporate global risk

management . . .management . . .

Earnings-at-Risk (EaR)

• Identification: Data Collection of Cash Flows with an Associated Market Risk Factor

• Aggregation & Quantification– Measurisk - EaR Analysis– Correlations & Volatilities– Portfolio approach - cross SBU

• Management of Risk– Risk limits– Derivative contracts– Business strategy or tactics

Distribution of Annualized Earnings OutcomesDistribution of Annualized Earnings Outcomes

0%

3%

5%

8%

10%-2.769447747

-2.582828822

-2.396209898

-2.209590973

-2.022972049

-1.836353124

-1.6497342

-1.463115275

-1.276496351

-1.089877426

-0.903258502

-0.716639578

-0.530020653

-0.343401729

-0.156782804

0.02983612

0.216455045

0.403073969

0.589692894

0.776311818

0.962930743

1.149549667

1.336168592

1.522787516

1.709406441

1.896025365

2.08264429

2.269263214

2.455882139

2.642501063

2.829119987

More

% P

roba

bilit

y

.0%

25.0%

50.0%

75.0%

100.0%

Cum

ulat

ive

%

$100 MMBudgeted Earnings

Equals the Earningsat the 95% CI

$75 MM

$25 MM = EAR

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• A monthly EaR of $50 MM means: On Average, one month in 20 you would expect a variance of $50 MM from (forecast) budget levels due to market movements

• Only 5% of the time would you anticipate exceeding your EaR

Distribution of Annualized Earnings Outcomes

PercentProbability

25%

20%

15%

10%

5%

0%

Earnings($ millions)

$300Equals the expectedor budgeted ATOI

$250Equals the earningscorresponding to the

95% CI

What Does EaR Mean?What Does EaR Mean?

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EAR Summary by Month

0.00

50.00

100.00

150.00

200.00

250.00

300.00

Expected Earnings Earnings at Risk

For illustrative purposes only

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Earnings at Risk Contribution by SBUTime Horizon = 1 year

SBU #130%

SBU #220%

SBU #320%

SBU #410%

SBU #57%

SBU #67%

SBU #76%

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($100)

($50)

$0

$50

$100

$150

SBU EaR Hedge Effectiveness ComparisonTime Horizon = 1-year

EaR - Natural EaR - With Hedging

For illustrative purposes only

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Energy Feedstock #137%

Energy Feedstock #215%

Energy Feedstock #313%

Agriculture #12%

Agriculture #22%

Anticipated Local Currency Margins

28%

Floating Rate Debt3%

Earnings at Risk - what’s really at riskEarnings at Risk - what’s really at risk= $750 million= $750 million

For illustrative purposes only

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Corporate-Wide & SBU Specific Benefits of Corporate-Wide & SBU Specific Benefits of EaR MethodologyEaR Methodology

• Clarity of Risk Exposures: Improved clarity of exposures to enhance decision making

• Management of EPS Volatility: Better manage earnings volatility to optimize shareholder value

• Senior Management Improvement: Improved communication b/w senior management and the SBUs

• Performance Evaluation of Divisions: Internal and external evaluation on a return on risk basis.

• Improved Risk Management within the SBUs: Risk management expertise can be more readily applied to risk issues with the business’s

• Clear Accountability: Consistency b/w decision making responsibility and results can be established, e.g., business performance vs. hedge results

• Performance Evaluation: Performance can be viewed on a risk return basis

• Improved Communication: Clear communication b/w SBUs, and treasury or commodity risk management, ensuring exposures are understood, and appropriate hedging strategies are put in place

Benefits to DuPontBenefits to DuPont Benefits to SBUsBenefits to SBUs

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Goals of Risk ManagementGoals of Risk Management

Distribution after Risk ManagementDistribution after Risk ManagementInherentInherent

DistributionDistribution

Earnings

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EaR PartnershipEaR Partnership

• Partnership with Measurisk.com– Advisory Role

– Data & Modeling Capability

– FAS 133

• WEB Application – Input positions and perform risk analysis online

– Stress condition modeling