# P2.T6. Credit Risk (25%)

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### Errors Found in Study Notes P2.T6. Credit Risk

Hello @MBK This is the correct place to post any issues that you have found in the study notes. I know David has been extremely busy answering detailed questions in the forum, preparing new materials and working on many other tasks so he may have missed this post. Please continue to post anything that you feel is an error, and I will fix them as soon as they are reviewed by David. Thank...
Hello @MBK This is the correct place to post any issues that you have found in the study notes. I know David has been extremely busy answering detailed questions in the forum, preparing new materials and working on many other tasks so he may have missed this post. Please continue to post anything that you feel is an error, and I will fix them as soon as they are reviewed by David. Thank...
Hello @MBK This is the correct place to post any issues that you have found in the study notes. I know David has been extremely busy answering detailed questions in the forum, preparing new materials and working on many other tasks so he may have missed this post. Please continue to post...
Hello @MBK This is the correct place to post any issues that you have found in the study notes. I know David has been extremely busy answering detailed questions in the forum, preparing new...
Replies:
6
Views:
713
2. ### P2.T6.142.1

Hi All, 142.1. Which of the following inputs is NOT required to estimate the probability default (PD) under the Merton/KMV model? a) Riskfree rate b) Firm (asset) volatility c) Debt capital structure (default point) 4. d) Market value of firm equity The inputs to estimate the PD are the Firm asset value, Debt value, Firm volatility, and drift. Could someone explain how to...
Hi All, 142.1. Which of the following inputs is NOT required to estimate the probability default (PD) under the Merton/KMV model? a) Riskfree rate b) Firm (asset) volatility c) Debt capital structure (default point) 4. d) Market value of firm equity The inputs to estimate the PD are the Firm asset value, Debt value, Firm volatility, and drift. Could someone explain how to...
Hi All, 142.1. Which of the following inputs is NOT required to estimate the probability default (PD) under the Merton/KMV model? a) Riskfree rate b) Firm (asset) volatility c) Debt capital structure (default point) 4. d) Market value of firm equity The inputs to estimate the PD...
Hi All, 142.1. Which of the following inputs is NOT required to estimate the probability default (PD) under the Merton/KMV model? a) Riskfree rate b) Firm (asset) volatility c) Debt...
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0
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8
3. ### Merton drift in DD

Hi All, P2.T6.R43 I am trying to conceptually understand how the DD value is calculated statistically. The numerator is the expected value of the price, and the denominator is the standard deviation. My question relates to the numerator. Assume T-t=1 ln(Vo/K) is the current log "return" at T=0. We then add what I assume is the expected drift until maturity (r-(sig^2)/2). How am I supposed...
Hi All, P2.T6.R43 I am trying to conceptually understand how the DD value is calculated statistically. The numerator is the expected value of the price, and the denominator is the standard deviation. My question relates to the numerator. Assume T-t=1 ln(Vo/K) is the current log "return" at T=0. We then add what I assume is the expected drift until maturity (r-(sig^2)/2). How am I supposed...
Hi All, P2.T6.R43 I am trying to conceptually understand how the DD value is calculated statistically. The numerator is the expected value of the price, and the denominator is the standard deviation. My question relates to the numerator. Assume T-t=1 ln(Vo/K) is the current log "return" at...
Hi All, P2.T6.R43 I am trying to conceptually understand how the DD value is calculated statistically. The numerator is the expected value of the price, and the denominator is the standard...
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0
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15
4. ### Total Return Swap (Crouhy) - Figure 12-7 - mistake?

many thanks, David! Apologies,I was referring to Crouhy's first edition in my question (there it is Figure 12-7). Now it makes good sense.
many thanks, David! Apologies,I was referring to Crouhy's first edition in my question (there it is Figure 12-7). Now it makes good sense.
many thanks, David! Apologies,I was referring to Crouhy's first edition in my question (there it is Figure 12-7). Now it makes good sense.
many thanks, David! Apologies,I was referring to Crouhy's first edition in my question (there it is Figure 12-7). Now it makes good sense.
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3
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5. ### MtM and Exposure for Netting

Hi @arkabose Yes, agreed. Your circled item is from the source (Gregory) and it's not listed in his errata that I can see (). However, I agree with you. This looks like a mistake to me (sorry). Your second paragraph, of course, is CORRECT: in a fixed cross-currency swap, the counterparty who pays the higher interest rate has a positive expected future M2M; i.e., the higher relative rate, per...
Hi @arkabose Yes, agreed. Your circled item is from the source (Gregory) and it's not listed in his errata that I can see (). However, I agree with you. This looks like a mistake to me (sorry). Your second paragraph, of course, is CORRECT: in a fixed cross-currency swap, the counterparty who pays the higher interest rate has a positive expected future M2M; i.e., the higher relative rate, per...
Hi @arkabose Yes, agreed. Your circled item is from the source (Gregory) and it's not listed in his errata that I can see (). However, I agree with you. This looks like a mistake to me (sorry). Your second paragraph, of course, is CORRECT: in a fixed cross-currency swap, the counterparty who...
Hi @arkabose Yes, agreed. Your circled item is from the source (Gregory) and it's not listed in his errata that I can see (). However, I agree with you. This looks like a mistake to me (sorry)....
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6. ### Netting factor

Thanks vm for the confirmation David. Makes sense with this lower bound. Rgds,
Thanks vm for the confirmation David. Makes sense with this lower bound. Rgds,
Thanks vm for the confirmation David. Makes sense with this lower bound. Rgds,
Thanks vm for the confirmation David. Makes sense with this lower bound. Rgds,
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7. ### GARP.FRM.PQ.P22016 GARP PQ - Question 5 - CDS

Hi @no_ming Yes, both are clearly in the syllabus. CDS valuation never left the syllabus (in 10+ years) although previously it was assigned to Hull's chapter on Credit derivatives. Thanks,
Hi @no_ming Yes, both are clearly in the syllabus. CDS valuation never left the syllabus (in 10+ years) although previously it was assigned to Hull's chapter on Credit derivatives. Thanks,
Hi @no_ming Yes, both are clearly in the syllabus. CDS valuation never left the syllabus (in 10+ years) although previously it was assigned to Hull's chapter on Credit derivatives. Thanks,
Hi @no_ming Yes, both are clearly in the syllabus. CDS valuation never left the syllabus (in 10+ years) although previously it was assigned to Hull's chapter on Credit derivatives. Thanks,
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8. ### GARP.FRM.PQ.P22016 GARP PQ - Question 52 -Netting

Hi @no_ming In this question, the type of instruments don't really matter as the question is giving you the mark-to-market value ("current market value") of the positions. Credit exposure is max(value, 0). So the credit exposure here without netting is 54, but with netting it is only 21: Without netting: max(0, +21) + max(0, -33) + max(0, +33) = 54 With netting: max(0, 21 - 33 + 33) = 21
Hi @no_ming In this question, the type of instruments don't really matter as the question is giving you the mark-to-market value ("current market value") of the positions. Credit exposure is max(value, 0). So the credit exposure here without netting is 54, but with netting it is only 21: Without netting: max(0, +21) + max(0, -33) + max(0, +33) = 54 With netting: max(0, 21 - 33 + 33) = 21
Hi @no_ming In this question, the type of instruments don't really matter as the question is giving you the mark-to-market value ("current market value") of the positions. Credit exposure is max(value, 0). So the credit exposure here without netting is 54, but with netting it is only...
Hi @no_ming In this question, the type of instruments don't really matter as the question is giving you the mark-to-market value ("current market value") of the positions. Credit exposure is...
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1
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9. ### de Servigny, Chapter 3 - Spreadsheet

Hello @mh2452 Any spreadsheets that are not published under the individual readings are published under that topic's Topic Review section in spreadsheet bundles. So if you to into Topic 6, you will find the spreadsheet bundles for that topic. I hope this helps! Nicole
Hello @mh2452 Any spreadsheets that are not published under the individual readings are published under that topic's Topic Review section in spreadsheet bundles. So if you to into Topic 6, you will find the spreadsheet bundles for that topic. I hope this helps! Nicole
Hello @mh2452 Any spreadsheets that are not published under the individual readings are published under that topic's Topic Review section in spreadsheet bundles. So if you to into Topic 6, you will find the spreadsheet bundles for that topic. I hope this helps! Nicole
Hello @mh2452 Any spreadsheets that are not published under the individual readings are published under that topic's Topic Review section in spreadsheet bundles. So if you to into Topic 6, you...
Replies:
1
Views:
60

Hi @no_ming Your question is good because sometimes default is assumed to refer to only the principal (as your solution infers), however here (in my opinion) the question does specify "accumulates 6.625 mm of losses from defaults and unpaid interest." And, this is natural (yes?): losses should refer to both unpaid principal and unpaid interest. So, given the phrasing, appropriate would be...
Hi @no_ming Your question is good because sometimes default is assumed to refer to only the principal (as your solution infers), however here (in my opinion) the question does specify "accumulates 6.625 mm of losses from defaults and unpaid interest." And, this is natural (yes?): losses should refer to both unpaid principal and unpaid interest. So, given the phrasing, appropriate would be...
Hi @no_ming Your question is good because sometimes default is assumed to refer to only the principal (as your solution infers), however here (in my opinion) the question does specify "accumulates 6.625 mm of losses from defaults and unpaid interest." And, this is natural (yes?): losses should...
Hi @no_ming Your question is good because sometimes default is assumed to refer to only the principal (as your solution infers), however here (in my opinion) the question does specify "accumulates...
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11. ### PFE & EE Question~

@no_ming Re: In another word, not only EE, if Sigma and mean increase, PFE, EPE etc. also increase, is that right? Yes, if you increase µ or σ then you are shifting or "expanding" (dispersing) the normal distribution, so the x% PFE will increase, in the same way that higher volatility or lower return will increase (absolute) value at risk because there x% tail (quantile) is further into loss...
@no_ming Re: In another word, not only EE, if Sigma and mean increase, PFE, EPE etc. also increase, is that right? Yes, if you increase µ or σ then you are shifting or "expanding" (dispersing) the normal distribution, so the x% PFE will increase, in the same way that higher volatility or lower return will increase (absolute) value at risk because there x% tail (quantile) is further into loss...
@no_ming Re: In another word, not only EE, if Sigma and mean increase, PFE, EPE etc. also increase, is that right? Yes, if you increase µ or σ then you are shifting or "expanding" (dispersing) the normal distribution, so the x% PFE will increase, in the same way that higher volatility or lower...
@no_ming Re: In another word, not only EE, if Sigma and mean increase, PFE, EPE etc. also increase, is that right? Yes, if you increase µ or σ then you are shifting or "expanding" (dispersing) the...
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12. ### PQ-externalCVA & credit limit question:

Mr. Harper, very clear explanation , thanks a lot. Dr. Jayanthi Sankaran, also thanks for your help.
Mr. Harper, very clear explanation , thanks a lot. Dr. Jayanthi Sankaran, also thanks for your help.
Mr. Harper, very clear explanation , thanks a lot. Dr. Jayanthi Sankaran, also thanks for your help.
Mr. Harper, very clear explanation , thanks a lot. Dr. Jayanthi Sankaran, also thanks for your help.
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3
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13. ### Equity tranche spread wrt correlation

Hello Sir, Can you please help me with the below question Question 1 Part a) Consider the following assets present in loan portfolio of IMT Bank Ltd, all the assets below are mortgage loans. Exposure 1 Exposure 2 Exposure 3 Portfolio Commitment $100,000,000$120,000,000 ...
Hello Sir, Can you please help me with the below question Question 1 Part a) Consider the following assets present in loan portfolio of IMT Bank Ltd, all the assets below are mortgage loans. Exposure 1 Exposure 2 Exposure 3 Portfolio Commitment $100,000,000$120,000,000 ...
Hello Sir, Can you please help me with the below question Question 1 Part a) Consider the following assets present in loan portfolio of IMT Bank Ltd, all the assets below are mortgage loans. Exposure 1 Exposure 2 Exposure 3 ...
Hello Sir, Can you please help me with the below question Question 1 Part a) Consider the following assets present in loan portfolio of IMT Bank Ltd, all the assets below are mortgage loans. ...
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14. ### GARP.FRM.PQ.P2question in derivation process of merton model credit spread

Logarithm quotient rule logb(x / y) = logb(x) - logb(y) is the formula used for calculation its not 1/x it x/y ...
Logarithm quotient rule logb(x / y) = logb(x) - logb(y) is the formula used for calculation its not 1/x it x/y ...
Logarithm quotient rule logb(x / y) = logb(x) - logb(y) is the formula used for calculation its not 1/x it x/y ...
Logarithm quotient rule logb(x / y) = logb(x) - logb(y) is the formula used for calculation its not 1/x it x/y ...
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Hi to all! If I understood correctly, banks apply a commitment fee (fixed percentage) on the undrawn portion of a credit line to hedge the further expected loss associated with that credit exposition. So you have to pay more if you are using a small drawn portion of the credit line. Now, given the fact that a firm with an high rating (such as AA or A) will only use a small part of the credit...
Hi to all! If I understood correctly, banks apply a commitment fee (fixed percentage) on the undrawn portion of a credit line to hedge the further expected loss associated with that credit exposition. So you have to pay more if you are using a small drawn portion of the credit line. Now, given the fact that a firm with an high rating (such as AA or A) will only use a small part of the credit...
Hi to all! If I understood correctly, banks apply a commitment fee (fixed percentage) on the undrawn portion of a credit line to hedge the further expected loss associated with that credit exposition. So you have to pay more if you are using a small drawn portion of the credit line. Now, given...
Hi to all! If I understood correctly, banks apply a commitment fee (fixed percentage) on the undrawn portion of a credit line to hedge the further expected loss associated with that credit...
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0
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61
16. ### Credit Exposure

Hi @Stuti It's the same square root rule that let's us scale volatility/VaR per sqrt(ΔT) but therefore importantly it is conditional on the same i.i.d. assumption, namely that the returns of the credit risk factor are independent. Further, this is the simplest possible credit exposure profile; i.e., a single i.i.d. credit risk factor. For example, in a swap, sqrt(ΔT) tends to characterize...
Hi @Stuti It's the same square root rule that let's us scale volatility/VaR per sqrt(ΔT) but therefore importantly it is conditional on the same i.i.d. assumption, namely that the returns of the credit risk factor are independent. Further, this is the simplest possible credit exposure profile; i.e., a single i.i.d. credit risk factor. For example, in a swap, sqrt(ΔT) tends to characterize...
Hi @Stuti It's the same square root rule that let's us scale volatility/VaR per sqrt(ΔT) but therefore importantly it is conditional on the same i.i.d. assumption, namely that the returns of the credit risk factor are independent. Further, this is the simplest possible credit exposure...
Hi @Stuti It's the same square root rule that let's us scale volatility/VaR per sqrt(ΔT) but therefore importantly it is conditional on the same i.i.d. assumption, namely that the returns of the...
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1
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48
17. ### CDS pricing question!

Hi @no_ming Yes, on one level, that's correct: the question implies an increase in price and, if we naively assume that the price determines the collateral posted (as the question implies), then the price increase implies additional collateral is posted. As discussed, most of the price movement should be fundamental (i.e., changes in the reference's credit quality) but, as is always the case,...
Hi @no_ming Yes, on one level, that's correct: the question implies an increase in price and, if we naively assume that the price determines the collateral posted (as the question implies), then the price increase implies additional collateral is posted. As discussed, most of the price movement should be fundamental (i.e., changes in the reference's credit quality) but, as is always the case,...
Hi @no_ming Yes, on one level, that's correct: the question implies an increase in price and, if we naively assume that the price determines the collateral posted (as the question implies), then the price increase implies additional collateral is posted. As discussed, most of the price movement...
Hi @no_ming Yes, on one level, that's correct: the question implies an increase in price and, if we naively assume that the price determines the collateral posted (as the question implies), then...
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8
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268
18. ### Real world application: Deriving default probabilities from observed CDS spreads

Hi there, I have to solve a problem which is actually a real world application of Malz, Chapter 7 - Bootstrapping default probabilities given an observable CDS spread curve. Please refer to the excel attached: I have created an excel spreadsheet that should do the calculation. What it basically does is - given an observable CDS spread curve - modelling the cash flows of a hypothetical CDS...
Hi there, I have to solve a problem which is actually a real world application of Malz, Chapter 7 - Bootstrapping default probabilities given an observable CDS spread curve. Please refer to the excel attached: I have created an excel spreadsheet that should do the calculation. What it basically does is - given an observable CDS spread curve - modelling the cash flows of a hypothetical CDS...
Hi there, I have to solve a problem which is actually a real world application of Malz, Chapter 7 - Bootstrapping default probabilities given an observable CDS spread curve. Please refer to the excel attached: I have created an excel spreadsheet that should do the calculation. What it...
Hi there, I have to solve a problem which is actually a real world application of Malz, Chapter 7 - Bootstrapping default probabilities given an observable CDS spread curve. Please refer to the...
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0
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140
19. ### Credit curve and CVA

Hi @taunk , Yes, typo on my end. You're right. Explanation became a little too wordy so I missed my own typo . Thanks for correcting!
Hi @taunk , Yes, typo on my end. You're right. Explanation became a little too wordy so I missed my own typo . Thanks for correcting!
Hi @taunk , Yes, typo on my end. You're right. Explanation became a little too wordy so I missed my own typo . Thanks for correcting!
Hi @taunk , Yes, typo on my end. You're right. Explanation became a little too wordy so I missed my own typo . Thanks for correcting!
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20. ### Marginal CVA

Hi @ami44 In regard to to Gregory's Table 12.6 above, I would just add: On the total line, there is only a summation of standalone CVAs (392,973) which is maybe not so useful except as as unrealistic, undiversified CVA (but diversification here, just exactly as @ami44 says, is a dynamic really due to the netting agreement in the netting set) versus the "actual" (i.e., diversified at the...
Hi @ami44 In regard to to Gregory's Table 12.6 above, I would just add: On the total line, there is only a summation of standalone CVAs (392,973) which is maybe not so useful except as as unrealistic, undiversified CVA (but diversification here, just exactly as @ami44 says, is a dynamic really due to the netting agreement in the netting set) versus the "actual" (i.e., diversified at the...
Hi @ami44 In regard to to Gregory's Table 12.6 above, I would just add: On the total line, there is only a summation of standalone CVAs (392,973) which is maybe not so useful except as as unrealistic, undiversified CVA (but diversification here, just exactly as @ami44 says, is a dynamic really...
Hi @ami44 In regard to to Gregory's Table 12.6 above, I would just add: On the total line, there is only a summation of standalone CVAs (392,973) which is maybe not so useful except as as...
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21. ### Delivery squeeze

Hi @ami44, Just adding a little more to the CDS-bond basis = CDS spread - Asset swap spread An asset swap exchanges the coupon of a corporate bond for LIBOR plus a spread. Reproducing an example from Hull: Let's take a situation where the asset swap spread on a particular bond = 150 bps. There are three likely scenarios: 1) Bond Price = Par value of $100. The swap involves Company A paying... Hi @ami44, Just adding a little more to the CDS-bond basis = CDS spread - Asset swap spread An asset swap exchanges the coupon of a corporate bond for LIBOR plus a spread. Reproducing an example from Hull: Let's take a situation where the asset swap spread on a particular bond = 150 bps. There are three likely scenarios: 1) Bond Price = Par value of$100. The swap involves Company A paying...
Hi @ami44, Just adding a little more to the CDS-bond basis = CDS spread - Asset swap spread An asset swap exchanges the coupon of a corporate bond for LIBOR plus a spread. Reproducing an example from Hull: Let's take a situation where the asset swap spread on a particular bond = 150 bps....
Hi @ami44, Just adding a little more to the CDS-bond basis = CDS spread - Asset swap spread An asset swap exchanges the coupon of a corporate bond for LIBOR plus a spread. Reproducing an example...
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16
Views:
183