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Credit Risk
Brief Overview of the current “Sub-Prime” Triggered Financial Crisis and
the Impetus of understanding / reviewing Credit Risk Management Practices
Day One
The Fundamental Building Blocks of Credit Risk:
- Definition of Default / Credit Event
- Default Probability
- Exposure
- Recovery (Loss given Default)
Key Processes inherent in Sound Credit Risk Management:
- Credit Policies – The Role of the Credit Committee
- Customer Segmentation
- Accounting for Delinquent Loans (IFRS vs GAAP rules)
- Limits Setting & Monitoring
Customer Credit Rating Models
- A Synoptical Perspective on Internal Credit Rating Models
- Heuristic / Expert Models
- Classic Rating Questionnaires
- Qualitative Systems
- Expert Systems
- Fuzzy Logic Systems
- Statistical Models
- Multi Variate Discriminant Analysis (MVA) - Altman´s Z-Score/Zeta Model
- Regression Models: Logit and Probit
- Artificial Neural Nets
- Causal Models
- Option Pricing Models (KMV – DtD Model) - Case Study
- Cash Flow Simulation Models (regression & stochastical time series)
- Liquidity Constraints
- Hybrid Models
- Criteria required by Auditors for accepting internal Rating Models
- Models used by Rating Agencies
- Examples of Rating Models used by key industry players
- Retail Customers
- Corporates
- Financial Institutions
- Sovereign Borrowers
- Heuristic / Expert Models
Day Two
Components of Credit Risk
- Backtesting and Validation of Credit Rating Models
- Discriminatory Measures
- Gini Coefficient
- CAP Curve
- ROC Curve
- AUROC
- Pietra Index
- Bayesian Error Rate
- CIER Index
- Kolmogorov-Smirnov Test
- Calibration Process
- Brier Score
- Reliability Diagrams
- Calibration Backtesting
- Dealing with Low Default Portfolios
- Best Practice Validation Processes
Classical Components of Credit Risk Measurement
- Estimating Default Probabilities
- Mathematical Underpinning
- Marginal vs. Cumulative vs. Average Default Rates
- Transition Probabilities – Properties, Examples
- Actuarial Estimating Methods
- Market Implied Default Probabilities - term structure of spreads
- Case Study on Bond Spreads: Interpretation
- Inferring Default Likelihood from Equity Prices (Merton Model)
- Recovery Rates and LGD
- Statistical Estimates
- Market Implied Recovery Rates
- Estimating Exposure at Default
- Current vs. Potential Exposure
- Estimating Potential Exposure by Instrument Type
- Time Profile of Expected Exposure
- Case Study: Expected vs. Maximum Exposure for an Interest Rate Swap
- Case Study: Exposure Profile for an FX Swap
- Exposure Modifiers
- Marking to Market (brief Discussion on IAS stipulations)
- Margins
- Collateral
- Exposure Limits
- Re-couponing
- Netting Agreements (Gross Replacement Value vs. Net Replacement Value)
- ISDATM master netting agreements
- Basel II & Regulatory recognition
- Credit Triggers
- Time Puts
Day Three
Risk Mitigation and Capital Allocation Models
- Overview of Credit Products:
- Cash Products (loans & bonds incl the syndicated & leveraged loan market)
- Credit Derivative Products
- Credit Default Swaps
- First (of Basket) to Default
- Nth to Default
- CDS Indices
- Total Rate of Return Swaps
- Credit Spread Forward Options
- Credit Spreads Options Contracts
- Credit Default Swaps
- Pricing and Hedging Credit Derivatives
- Actuarial Approach
- Spread Methods
- Equity Pricing Methods
- Examples
- Structured Credit Products
- Credit Linked Notes
- Collateral Debt Obligations „CDOs“
- Balance Sheet vs. Arbitrage CDOs
- Cash Flow „funded“ vs. Synthetic CDOs
- Managed vs Static CDOs
- Market Value CDOs
- Other CDO related Structures
- CDO squared
- CDOs on ABS
- CDOs on CDOs
- CPDOs „Constant Proportional Debt Obligations“
- Pricing Structured Products
- Synthetic CDOs
- Generating Portfolio Loss Distributions - Conditional Survival Probabilities
- Demistifying Copulas
- Backtesting Default Correlations - Discussion
- Pricing a Tranche given the “unconditional“ Loss Distribution
- Value of the “Contingent Leg”
- Value of the “Fee Leg“
- Deriving Implied Correlations
- Generating Portfolio Loss Distributions - Conditional Survival Probabilities
- Cash CDOs
- The Asset Side
- The Liability Side
- Synthetic CDOs
Credit Portfolio Models
- Measuring Credit VAR
- CreditMetricsTM
- CreditRisk+TM
- Moody´s KMV Credit MonitorTM
- CreditPortfolioViewTM
Fitting it all together - RAROC Models
- Integrated Risk Management - Capital Allocation
- The Decision Process in the Credit Committee
- Incremental RAROC
- Marginal RAROC
- Regulatory Constraints (brief overview of Basel I vs. Basel II)
Off Balance Sheet Vehicles
- Conduit Structures
- SIVs
- Accounting Treatment
Lessons to be learned for Risk Managers and Credit Analysts from the Financial Crisis
Conclusions and Discussions