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chapter 9: portfolio management, chapter 11: regulation, Chapter 12:…
chapter 9: portfolio management
credit portfolio management
taking a big-picture view and manage the risk of the portfolio in its entirety
three levels of CPM
level 2
analytical skills and tools
techniques
quantification of capital at risk
allocation to capital and profitability at individual transaction level
stress testing
stress tests should be ''back tested'' with historical events
difference between var and stress testing- VAR- use historical data
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
hedging strategies
re-balancing transaction
level 3
have a profit and loss responsibility
techniques
transfer pricing
dispossess business units of their exposure immediately after closing a transaction
acquisition or swap of exposures
can acquire exposure in another sector
level 1
techniques
5.mitigation
transfer credit risk to another firm
4.surveillance
monitor
3.credit limit
2.reporting
1.aggregation
it need a common sense
chapter 11: regulation
benefits
2.improve solvency
need minimum capital adequacy ratio
3.provide better oversight and governance
additional layer of governance, disclose information and eliminate information asymmetry
1.better alignment of interest
alignment of creditors' interest and objective of regulator
better control systematic risk and contagion
systemic risk is lower in regulated environment
pitfalls
seizure and lack of orderly disposition
moral hazard
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
not all creditors are treated equally
gamesmanship
definition: regulation imposes too many operational constraints that impede entity's decisions
three forms of gamesmanship
regulatory arbitrage
innovate new products and processes to reduce the impact of regulatory costs
regulatory dialectic
regulators would react to change in financial market and draft new regulations to respond to impacts of the changes
organizational arbitrage
management place key personnel outside of regulatory supervision
rating arbitrage
CDO- A company take a credit risk exposure to gain a favorable regulatory treatment
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
known to have problems
general provision
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
companies defaults or goes into bankruptcy
what is impact
putting pressure on regulatory capital requirements and leverage ratios
higher capital ratio adequacy and higher leverage ratio
hedging accounting
accounting for cash-flow hedge
hedge exposure to cash-flow volatility
bond's change in value will not flow in income but rather than to other comprehensive income
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
accounting for macro hedge
Chapter 10:economic capital and Cvar
what is capital
is equity
regulatory capital
minimum capital requirements
shareholder's capital
book value of equity
economic capital
buffer against unexpected losses
Difference between default and credit risk
default view: there are no losses unless there is a default
Cvar
disadvantage of Cvar
2.depends on quality of data and analysis
3.backward looking
does not represent worst case scenario
three key aspects of Cvar
time horizon
exposure can be mitigated quickly, loss horizon chosen is short
CvaRS for longer time horizons will be larger
2.loss distribution
3.confidence interval
higher confidence level, lower risk appetite
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
Week 8
Week 9