Credit Risk Modelling This in-house course can also be presented face to face in-house for your company or via live in-house webinar

Transcription

1 Credit Risk Modelling This in-house course can also be presented face to face in-house for your company or via live in-house webinar The Banking and Corporate Finance Training Specialist

2 Course Content Day One Definitions of parameters used for modelling credit risk Introduction to credit risk models and their parameters Course Overview Credit event definition and exercise Loss-Given Default (LGD), Expected Loss (EL) and probability of Default (PD) Calibration of default probabilities to actual ratings Exposure at default (EAD) Relationship between PD, EAD, LGD Unexpected Loss (UL) Economic capital Loss distribution Monte Carlo simulation of losses Recovery rate (recovery payments) Workshop: Computation of theoretical credit spread for an amortizing asset with given LGD, PD and EAD at different maturity stages Market based methods CDS cash flows and default risk Unbundling a risky bond into default and other components Isolating underlying default risk using a single instrument Adding floating LIBOR-based payments Credit spread over swap rate Default-free money market deposit Floating Rate Note (FRN) Final adjustment to compensate coupon reduction Synthetic portfolio of cash flows Real world complications and hedging difficulties Counterparty default risk and liquidity Exercise: Assessment of the credit spread value for an asset given the market perception of the underlying credit risk and CDS / bond market information Concept of synthetic Credit Default Swap (CDS): Basis Trades Hedging / arbitraging CDS: positive and negative basis trades Bond and structured finance issuance CDS Fair Price : asset swap par spread implications CDS key issues: Over the counter (OTC) shortcomings Exercise and discussion: Using an asset swap to uncover market credit risk spreads. Unbundling the different risk component of an asset and using CDS to mitigate risks. Day Two Structural Firm Asset Volatility Models Black & Scholes / Merton Option Pricing Approach Key credit risk concepts Credit (default) risk as put option Merton / KMV Model (Firm Asset Volatility Model) Hybrid corporate securities. Options in corporate finance Credit risk: asymmetric information and agency costs Structural asset volatility (Black-Scholes / Merton) models Structural asset volatility (Moody s-kmv) models Embedded complexities of interim cash flows

3 Workshop: How to use various financial instruments to replicate an option (Black & Scholes) synthetically. How to derive Credit Spreads from a practical point of view. Black-Scholes / Merton KMV Option Pricing Approach Credit risk as a function of equity value Cost of hedging credit default risk Term structure of credit default risk spread Distance-to-default (DD) Probability of loss-given-default (PD) Exercise and discussion: How to price a Credit Default Swap with the use of a structural model by looking at both the premium value and protection legs. REDUCED-FORM MODELS (BASED ON INTENSITY OR TRANSITION) Part 1 Jarrow-Turnbull (JT) Reduced-Form Intensity Model: Applying Term Structure Models Stochastic term structure of default-free interest rates: Markov process for credit ratings Stochastic maturity specific credit-risk spread Implementing a discrete-time Markov model: Pricing risky bonds Pricing options on risky bonds Credit default swaps Exercise: How to price a Credit Default Swap with the use of a reduced-form approach model such as JLT and appreciate the implications of credit ratings Day Three REDUCED-FORM MODELS (BASED ON INTENSITY OR TRANSITION) Part 2 Jarrow-Lando-Turnbull (JLT) Rating-Based Transition Matrix Technology Applying Jarrow-Lando-Turnbull model Arbitrage-free restrictions of the model A discrete-time model in a two-period economy Credit ratings and default probabilities: mathematics underlying the JLT model Workshop: How to use a reduced-form transition matrix model based spreadsheet for pricing credit derivatives. Pricing Derivatives Contracts Under Collateral Agreements in Credit Support Annex (CSA), Credit Value Adjustment (CVA) Debt Value Adjustment (DVA), Liquidity / Funding Value Adjustments (LVA, FVA) Collateral agreements Collateral (initial margin) Variation margin Maintenance margin CSA contract agreements, aggregated base, netting set, Net Present Value (NPV) CSA Pricing: Discrete Setting Cox-Ross-Rubinstein binomial risk-neutral option pricing Non-collateralised contingent claims, collateralised claims, and liquidity value adjustment (LVA) Liquidity value adjustment LVA: discounted NPV between risk-free rate and collateral rate Exercise: How to assess the cost of replicating collateral account at predefined asset s path

4 Counterparty Credit Risk: Wrong Way Risk, CVA, FVA, & Liquidity Issues Counterparty contract risk exposure Wrong / right-way risk: CVA adjustment Wrong-way risk theoretical framework Expected positive exposure (EPE) Default intensity (PD) Credit value adjustment (CVA) of OTC derivatives CDS spread (PD, LGD), EPE Risk management: counterparty credit VaR Credit VaR and exposure: Current exposure (CE) Potential future exposure (PFE) Credit limits Expected exposure (EE) Exposure-at-default (EAD) Workshop: Analysing the various elements of Counterparty Risk with a practical example and the hedge with a contingent credit default swaps (CCDS) Final discussion and conclusions Course Summary For banks and financial institutions a sea of changes has occurred in the past few years as a response to the credit crisis. A new capital adequacy framework, strengthened and specific credit risk regulations under Basel II / III, and recent innovations in the credit derivative arena are all highlighting the increasing scrutiny on credit issues. More than ever before, financial institutions and large corporates will therefore have to be able to assess, calculate and model the embedded credit risk of assets as well as the risk generated by the use of counterparties for hedging or trading purposes. This course is designed to provide professionals with a broad understanding of modern credit risk modelling techniques. During this training programme, participants will look in details at some of the more important models used for the pricing of default risk inherent to holding assets or embedded within credit derivatives. The focus of the course together with the choice of exercises and examples will enable participants to understand the different stepping stones used in the design of the models in an easy way and the reasons why the models can be validated. Delegates will examine how different risk elements, such as interest rate, default and recovery values intertwine in those models. Participants will be able to appreciate the credit models commonly used to calculate EAD (Exposure at Default), PD (Probabilities of Default) and LGD (Loss Given Default) as well as counterparty risk assessment models based on potential future exposure at default. We examine recent modelling issues of funding and market liquidity, basis risk and counterparty risk, and learn the meaning and use of the different value adjustments and notions such as wrong-way risk and liquidity issues. Methodology: This course is highly interactive with presentations, exercises, examples, workshops and discussions. It is supported by a range of computer-based exercises to help delegates put the concepts covered into practice.

5 Who could benefit from this training programme? Credit Portfolio and Asset Managers Auditors Risk Analysts Credit Managers Financial Industry Regulators Financial Risk Managers Participants will be required to bring a laptop to the course. Redcliffe has provided in-house training for the following companies: enquiries@redcliffetraining.co.uk +44 (0)

6 Tailored Learning All of our training courses can be tailored to suit your company s exact training needs. We will work closely with you to help develop a training programme with content that is unique for your organisation. Please us on enquiries@redcliffetraining.co.uk for more information E-Learning This course can also be presented as a bespoke e-learning programme created by you to fit your exact requirements.

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