Credit Risk: From Transaction to Portfolio Management (eBook)

Cover 1
Contents 6
Preface 10
Acknowledgements 12
1 FIXED INCOME CREDIT: Managing credit within a fixed income portfolio 14
1.1 The credit product 14
Introduction 14
1.2 Government bonds and credit 16
1.3 Benchmarks for credit 19
Swap spreads 20
1.4 Corporate bonds 21
The primary market 23
The secondary market 24
Regulatory environment 25
Types of bond 25
1.5 Floating-rate notes 29
1.6 Credit related instruments 31
Reverse FRN 31
Capped FRN 34
Collared FRN 35
Equity-linked bonds 36
1.7 Asset-backed securities 39
1.8 International bonds 43
The issuance process 46
Syndicate members 47
Pricing 48
Fee structure 49
Valuation and subsequent management 49
Clearing systems 51
Regulation and taxation 52
International Securities Market Association 52
MTN market 52
1.9 Commercial paper 52
1.10 High yield bonds 54
1.11 Credit risk 57
1.12 Risk management of fixed income portfolios 67
Coupon bearing bond with standalone risk 72
Combining the two bonds 73
Gamma term 73
Higher-order risk and tail risk 75
A word on total risk 77
A word on types of spread 79
1.13 Credit Metrics’ 80
1.14 Credit Indices 83
The choice of index 83
The use of a credit index 84
A good index system 87
Swap-based indices 88
1.15 Optimizers 89
Marginal measures of risk 91
1.16 Vasicek-Kealhofer EDF model 92
1.17 Rating agencies 98
The rating process 101
References 101
2 THE LOAN PORTFOLIO: Loan portfolio management 102
2.1 What is loan portfolio management? 102
Introduction 102
2.2 The loan market 103
Syndicated market 103
The secondary market 104
2.3 Definitions 105
Term loan 105
Revolving credit facility 106
Standby facility 106
US syndicated market 106
2.4 Relative value analysis 107
2.5 Term sheet of a loan 108
2.6 The syndication process 108
Pre-mandate 108
Post-mandate 110
Post-signing 110
Duties and roles 110
The bidding process 110
Pricing the loan 111
Syndication strategy 114
2.7 Pricing within a commercial bank 115
2.8 Loan ratings 118
2.9 Risk management 120
2.10 Approaches to management 122
Goals of portfolio management 122
2.11 Economic vs. regulatory capital 124
2.12 CAR 126
Choice of horizon 126
What horizon length should we deploy? 127
Build of hurdle rate given a capital at risk (i.e. risk-adjusted return) 127
2.13 Loan case studies 129
Introduction to the case studies 129
The two asset portfolio 129
Loan revaluation 133
CAR for the portfolio 135
The 100 asset portfolio 136
2.14 Concentration management 137
How to define and manage concentration 137
2.15 Hedging techniques 138
Securitization 138
The asset portfolio 139
Credit default swap 140
Other credit derivatives 140
2.16 Central themes 141
Expected loss 141
Unexpected loss 141
The default frequency 143
Regulatory capital 144
Basel II 145
Technical detail of the models underlying the IRB 147
References 150
3 CREDIT DERIVATIVES: What are credit derivatives? 152
3.1 Introduction 152
3.2 Why use credit derivatives? 154
Confidentiality 154
Shorting credit 154
Off balance sheet nature 154
Convention in the market 155
Definition of a credit derivative 155
3.3 Definition of a credit event 155
ISDA Credit derivative policy 156
3.4 Credit default swap 156
3.5 Total return swap 158
TROR term sheet 159
Settlement 159
Funding opportunities 161
3.6 Securitization overview 162
A typical managed CDO structure 165
The synthetic CDO 166
Collateral quality 167
3.7 Dynamic credit swaps 169
3.8 Credit options 171
3.9 Credit linked note 173
3.10 First to default 173
3.11 The default swap basis 175
Long basis trade 176
Buying protection 176
Asset swap 177
3.12 Pricing 179
3.13 Source of pricing 181
3.14 Pricing examples 185
3.15 Regulatory environment 187
Regulatory capital 187
Regulatory capital example 189
3.16 Terminology 190
Obligation 190
Reference asset 190
Materiality 190
Substitution 191
Basis risk 191
2003 Update 192
Definition of bankruptcy as a credit event 192
Four types of restructuring clause 192
Definition of deliverable obligations 193
References 193
4 SECURITIZATION: Credit within the context of securitization 194
4.1 Asset-backed securities 194
Market review 194
Major types of securitization 196
4.2 Mortgage-backed securities 197
Tranche types 199
Sequential pay 199
Planned amortization 199
Targeted amortization 200
Support class 200
Floating-rate tranches 200
The call class 200
IO and PO mortgage-backed securities 200
4.3 Auto and loan-backed securities 200
European summary 202
4.4 Collateral analysis 202
4.5 Analysis of securities 206
Other ways of evaluating pre-payment 208
Modelling mortgages 209
4.6 The importance of credit derivatives 209
The use of a default swap 209
Glacier 211
Broad Index Secured Trust Offering 212
4.7 Collateralized debt obligations 213
Types of CDO 213
Arbitrage CDOs 213
Synthetic CLOs 215
4.8 CDO asset types 216
4.9 Credit enhancement 218
External credit enhancement 218
Internal credit enhancement 219
Construction of financial securities 219
The asset portfolio 220
Asset backing 220
4.10 Detailed evaluation of asset backing and enhancement 222
4.11 Investor analysis 227
Construction of financial securities 227
Valuation of the investment grade assets 229
References 230
5 THE CREDIT RISK OF INTEREST RATE PRODUCTS: Counterparty credit risk 232
5.1 Introduction 232
5.2 Exposures 233
Current exposure 233
Future exposure 234
Example 235
5.3 FRN analysis 238
5.4 Swap 243
Reference 245
6 THE FUNDAMENTALS OF CREDIT: Methodologies 246
6.1 The standalone loan 246
6.2 Standard measures 249
Cumulative default frequency 249
Marginal default probability 249
Conditional default probability 249
Default intensity 249
Survival probability 250
6.3 A portfolio as a set of standalones 250
6.4 Introducing correlation 253
Default correlations from default volatilities 255
6.5 Other approaches to default 257
Volatility with different rates which vary and are correlated 258
Higher order defaults 259
6.6 Copulas 259
6.7 Moody's diversity score 260
6.8 MKMV RiskCalc 261
References 262
INDEX 264
A 264
B 264
C 264
D 266
E 266
F 266
G 266
H 266
I 266
J 267
K 267
L 267
M 267
N 268
O 268
P 268
R 268
S 268
T 269
U 269
V 269
W 269
Y 269