Credit Quiz - Rnd 2

higaurav

New Member
Hi David,

There are two doubts I have from the new credit risk quiz (Round 2)

1) Which most nearly described the usage given default (UGD)?

In this I am not able to differentiate between ans A and B, reason being that UGD comes as an option to take more loan... and in stock put and call both provides option to buyer so how are we comparing this with loan in this case.

2)Because recoveries are stochastic (random), loss given default (LGD) deserves to be characterized by a range or distribution rather than a point-estimate. The beta distribution is well-suited to characterize loss given default (LGD) due to its flexibility. LGD can model each of the following EXCEPT:

Please can you elaborate on ans little more as am not able to understand the explanation.

Appreciate you help and guidance on this. Thanks a ton :)
OM
 

David Harper CFA FRM

David Harper CFA FRM
Subscriber
Hi OM

1) I think I agree with you. (frankly, I was trying to round out the three alternatives). Ong says UGD is a "credit option that is granted by the bank to the obligor in exchange for a premium..." I cannot refute your point that: it is an option. For my part, it *feels* like a call option rather than a put because the borrower isn't short the line of credit; i.e., to "trigger" the option is to "come into ownership" of the the credit line. I *feels* like naturally like a call option, but no matter, if we debate this, you are winning on logic. And, in either case, we are at the very least knowing what he means by "credit optionality"

2) Notice is is not key for the question, I threw that in there solely to remind you about a point in Ong (and that would be consistent with de Servigy). Basically it is saying:

we can estimate PD with values like 0.2% or 1% (point estimates)
But LGD is so random (stochastic; hard to parameterize) that saying LGD = 45% is FALSE PRECISION. Rather, are better to say LGD = 30% to 60%

Reminds me of a saying, better to be roughly accurate than precisely wrong!

David
 
Top