chapter 9: portfolio management

  1. credit portfolio management

three levels of CPM

level 2

level 3

level 1

techniques

it need a common sense

5.mitigation

4.surveillance

3.credit limit

2.reporting

1.aggregation

transfer credit risk to another firm

monitor

analytical skills and tools

techniques

quantification of capital at risk

allocation to capital and profitability at individual transaction level

stress testing

hedging strategies

re-balancing transaction

stress tests should be ''back tested'' with historical events

difference between var and stress testing- VAR- use historical data

have a profit and loss responsibility

techniques

transfer pricing

acquisition or swap of exposures

can acquire exposure in another sector

dispossess business units of their exposure immediately after closing a transaction

Chapter 10:economic capital and Cvar

what is capital

is equity

regulatory capital

shareholder's capital

economic capital

buffer against unexpected losses

minimum capital requirements

book value of equity

Difference between default and credit risk

default view: there are no losses unless there is a default

Cvar

disadvantage of Cvar

three key aspects of Cvar

what is Cvar

estimate of credit risk : the difference between expected and unexpected losses on a credit portfolio over a certain time horizon expressed at a certain level statistical confidence

  1. time horizon

2.loss distribution

exposure can be mitigated quickly, loss horizon chosen is short

 CvaRS for longer time horizons will be larger

3.confidence interval

higher confidence level, lower risk appetite

2.depends on quality of data and analysis

3.backward looking

  1. does not represent worst case scenario

chapter 11: regulation

benefits

2.improve solvency

3.provide better oversight and governance

1.better alignment of interest

  1. better control systematic risk and contagion

alignment of creditors' interest and objective of regulator

need minimum capital adequacy ratio

additional layer of governance, disclose information and eliminate information asymmetry

systemic risk is lower in regulated environment

pitfalls

seizure and lack of orderly disposition

moral hazard

not all creditors are treated equally

banks would have incentives to take on more risks

creditors may rely too heavily on regulator's work and lack of due diligence

customers would do business with regulated entity

gamesmanship

definition: regulation imposes too many operational constraints that impede entity's decisions

three forms of gamesmanship

regulatory arbitrage

organizational arbitrage

innovate new products and processes to reduce the impact of regulatory costs

management place key personnel outside of regulatory supervision

why is matter

because day to day business of an entity and internal management activities are under the influence of regulation

Chapter 12: accounting implication of credit risk

what is loan impairment

unable to collect all amount

specific provision

general provision

known to have problems

known to have problems in the aggregate but without knowing particular loans

loan loss accounting

contra asset

expected impairment

accounting for netting

netting

two counterparties owe each other money and under a legally enforceable agreement, they are allowed to net the two sums

when

what is impact

companies defaults or goes into bankruptcy

putting pressure on regulatory capital requirements and leverage ratios

higher capital ratio adequacy and higher leverage ratio

hedging accounting

accounting for cash-flow hedge

accounting for fair-value hedge

use derivative to offset an exposure to changes in the fair value of an asset or liability

with hedging

bond's change in value will be recognized in income, rather than other comprehensive income

OCI

revenues that have yet to be realized

hedge exposure to cash-flow volatility

bond's change in value will not flow in income but rather than to other comprehensive income

rating arbitrage

CDO- A company take a credit risk exposure to gain a favorable regulatory treatment

accounting for macro hedge

taking a big-picture view and manage the risk of the portfolio in its entirety

Week 8

Week 9

The process also helps manager to understand the nature of portfolio. It ensures the capital is correctly allocated to support a reasonable level of risk.

stress testing measures the vulnerablility of individual exposure and portfolio to extreme yet possible events

regulatory dialectic

regulators would react to change in financial market and draft new regulations to respond to impacts of the changes