MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANC IAL CONDITION For investments and investment portfolios, we have established MVE and EV risk measures using 10-day holding periods, as well as holding periods that best reflect estimates of the time necessary to liquidate positions. In addition, where appropriate, specific measures are used for the credit-related risk and other concentrations of risk embedded in those positions. Structural market risk arises primarily from retail and  commercial asset and liability interest rate mismatches and embedded options, and from foreign currency transaction risk that affects net income. BMO manages its structural market risk to support the stability of its earnings. This involves managing asset-liability mismatches to a target profile and maintaining option and foreign currency transaction risks at low levels. Structural MVE and EV risk measures reflect a three-month  holding period for Canadian dollar balance sheet items and  a two-month holding period for U.S. dollar balance sheet items. In addition to structural MVE and EV risk measures, we also use interest rate gap analysis (see Table 19 on page 62), simulation modelling and sensitivity analysis to measure structural interest rate risk. Sensitivity analysis to an interest rate increase or decrease of 100 basis points is disclosed in the table below. This sensitivity analysis is performed and disclosed by many financial institutions and facilitates comparisons with our peers. Limits are reviewed by the Risk Review Committee of the Board of Directors at least annually, and anticipate a wide range of market environments at a 99% confidence level. This review takes into consideration BMO’s risk appetite and risk exposure. The market risk limits approved by the Risk Review Committee of the Board of Directors were not exceeded during the year. Processes and models are used to measure and value our portfolio exposures and to calculate the related market risk exposure. For trading and underwriting activities, the determination of daily net trading revenue also relies on these models and processes. We have strong controls over the development, implementation and application of these processes and models. Models are subject to a periodic independent model risk  vetting process and, where appropriate, additional testing  and analysis. Such testing seeks to determine those inputs or assumptions to which a model is most sensitive and those that are the most likely to vary or create unusual changes in the model’s output. This provides an understanding of the range of possible outputs that can be derived from the model. We monitor the application of models to ensure that they are appropriate to the particular portfolio to which they are applied, and we take corrective action, including making adjustments to the determination of daily net trading revenue, when model limitations are identified. The models used to measure market risks are effective at measuring such risks under normal market conditions. In addi- tion, we perform scenario analysis and stress testing to determine the impact of unusual and/or unexpected market changes on our portfolios. We use a comprehensive set of scenarios and stress tests, and the results are reported to senior management on a regular basis. Exposures in trading and underwriting portfolios must be managed within pre-set stress limits. Backtesting is an integral tool in the processes used to validate BMO’s market risk models. We use a variety of methods to  ensure the integrity of these models, including the application of backtesting against hypothetical losses. For all trading and underwriting portfolios, this process assumes there is no change in the previous day’s closing portfolio positions. The process then isolates the effects of each day’s price movements against these closing positions. Models are considered to be validated by such testing if, on average, calculated hypothetical losses exceed the VaR measure only one time out of 100. Results of this testing confirm the validity of our models. The Risk Review Committee of the Board of Directors approves limits for MVE and EV within which market risk activities  are conducted. Comprehensive market risk limits have been established for all units engaged in market risk activities, and for BMO as a whole. The limits govern both the magnitude of risk (expressed in MVE and EV terms) and specific concentra- tions of risk. In addition, there are loss limits that provide  senior management with early warning signals to effectively address potential loss situations. These limits are set in rela- tion to the particular strategies of each line of business, the extent of its customer-driven business and its revenue prospects. The market risk governance structure helps ensure that limits are observed and that any breach of these limits is promptly  and effectively addressed.  Managing liquidity and funding risk is a key component of our enterprise-wide risk management framework, and is essential to maintaining both depositor confidence and stability in earnings. We manage liquidity and funding risk by ensuring that sufficient liquid assets and funding capacity are available to meet financial Liquidity and funding risk  is the risk of being unable to meet financial commitments in a timely manner at reasonable prices as they fall due. Financial commitments include liabilities to depositors and suppliers, and lending and investment commitments. 32 BMO FINANCIAL GROUP ANNUAL REPORT 2002 Liquidity and Funding Risk Limits  Structural Interest Rate Sensitivity Processes and Models  *Exposures are in brackets and benefits are represented by positive amounts. (After-tax Canadian equivalent)  ($ millions)*  As at October 31, 2002 As at October 31, 2001 100 basis point 100 basis point 100 basis point 100 basis point increase decrease increase decrease Earnings sensitivity over  the next 12 months $ 1.1 $ (0.1) $ 9.4 $ (20.5) Economic value sensitivity $ (152.7) $ 123.8 $ (147.0) $ 64.2