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    Credit Assessment Presentation

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    Melvern Salim
    The document summarizes the answers provided by Yuankun Hou to questions in a credit risk management tutorial. [1] Default probability is computed using a company's internal or external credit rating, which analyzes its financial statements, and translating the rating into a default probability using historical data. [2] The major elements that influence recovery rates include the value of total assets at default, the seniority of claims, and the amount of collateral/security pledged. More assets, senior claims, and collateral lead to higher recovery rates. [3] The drivers of expected loss are exposure, default probability, one minus the recovery rate, which captures how much loss is not recovered. Expected loss is a statistical

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    Credit Assessment Presentation

    Uploaded by

    Melvern Salim
    11 views12 pages
    The document summarizes the answers provided by Yuankun Hou to questions in a credit risk management tutorial. [1] Default probability is computed using a company's internal or external credit rating, which analyzes its financial statements, and translating the rating into a default probability using historical data. [2] The major elements that influence recovery rates include the value of total assets at default, the seniority of claims, and the amount of collateral/security pledged. More assets, senior claims, and collateral lead to higher recovery rates. [3] The drivers of expected loss are exposure, default probability, one minus the recovery rate, which captures how much loss is not recovered. Expected loss is a statistical

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    The document summarizes the answers provided by Yuankun Hou to questions in a credit risk management tutorial. [1] Default probability is computed using a company's internal or external credit rating, which analyzes its financial statements, and translating the rating into a default probability using historical data. [2] The major elements that influence recovery rates include the value of total assets at default, the seniority of claims, and the amount of collateral/security pledged. More assets, senior claims, and collateral lead to higher recovery rates. [3] The drivers of expected loss are exposure, default probability, one minus the recovery rate, which captures how much loss is not recovered. Expected loss is a statistical

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    11 views12 pages

    Credit Assessment Presentation

    Uploaded by

    Melvern Salim
    The document summarizes the answers provided by Yuankun Hou to questions in a credit risk management tutorial. [1] Default probability is computed using a company's internal or external credit rating, which analyzes its financial statements, and translating the rating into a default probability using historical data. [2] The major elements that influence recovery rates include the value of total assets at default, the seniority of claims, and the amount of collateral/security pledged. More assets, senior claims, and collateral lead to higher recovery rates. [3] The drivers of expected loss are exposure, default probability, one minus the recovery rate, which captures how much loss is not recovered. Expected loss is a statistical

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 12

    Week 7 tutorial answers

    Presenter: Yuankun Hou


    Question 6.1 How is default probability computed?
     Assign a rating which represents the credit quality to a counterparty by
    analyzing its financial statements.
    o Internal rating:
    Using internal credit assessment team which can only be afforded by large
    companies rather than small companies.
    Large companies have their own proprietary methodologies and rating scale.
    Professionals are employed to perform credit assessment and rating.
    o Rating agencies:
    Rating agencies can provide companies with an option of rating about credit
    quality.
     Using historical date to translate a rating ratio into a default probability.
    Question 6.2 What are the major elements that
    influence recovery rates?
    Loss Given Default = 1 – recovery rate
    Thus, recovery rates are mainly affected by:
     Value of total assets at the time of default.
    The higher the total assets, the higher possibility to recover the loss;
     Seniority of claims: senior, junior/ subordinate
    The more senior the creditor, the greater the recovery;
     Collateral/ security: secured, unsecured
    The more the collateral, the more loss could be recovered.
    Question 6.3 Explain the drivers of expected loss in
    figure 4.5.

     Exposure: This is the amount at risk and has correlations with collateral and the
    size of unused facility;
    It can be fixed or dynamic.
     Default probability: the credit quality typically summarized by a rating;
    Based on historical data.
     1- recovery rate: mainly influenced by three elements.
     The expected loss is just a statistical measure that on a stand-alone basis, it is
    important to price correctly and calculate the accumulated expected loss.
    Question 6.4 Explain how Figure 5.2 is like a call
     the situations of this are: the
    agreed price between two party is
    $3, Trader & Co. will provide
    Utility Corp. 100,000 gallons of
    oil per month, The contract is
    valid for 5 years;
     Utility is to avoid the upward risk
    of oil price and stick at a strike
    price, which is likely to the call’s
    purpose.
     When price rises above the strike
    price, both this agreement and the
    call option make a good deal.
    Question 6.5 Why is value at Risk a critical tool for a
    credit risk manager
     The Mark to Market captures the current value of the credit exposure but
    does not provide any information about the future exposure.
     Risk managers need to have a forward looking more than the Mark to
    market because there are many dynamic credit exposures.
     The Value at Risk can provide risk managers information about what
    range of exposure could be in future, which could also help managers
    make decisions.
     Value at Risk is an estimation of the expected maximum credit exposure,
    within a specific confidence interval and time horizon. If there is a 5% of
    having credit exposure in excess of $ 10million, it can be concluded that
    you are confident that in 95 of 100 cases, the credit exposure will not be
    in excess of $10million.
    Question 6.6 Discuss the incentives of the creditors
    and shareholders that give rise to the fundamental
    agency conflict between the two groups.
     The agency conflict arises from the different interest between creditors and
    shareholders and their attitude towards the risk-taking activities:

     For shareholders: they pursue maximizing the profit.


    They would like to get involved in risk-taking activities for greater gain.

     For creditors: they are interested in limiting the risk-taking policies of their
    borrowers, they want to keep the return on their investment are stable.
    They don’t like risk.
    Continue 6.6
     when asset value is greater
    than debt, shareholders
    obtain greater gain, while
    debt holders still get the
    fixed repayment.
     When asset value is less
    than debt, debt holders still
    can be repaid and
    shareholders cannot gain
    anything, may lose to
    interest to invest and
    operate.
    Question 6.7 How did Robert Merton in the 1970s
    capture this relationship
     In this model, Merton expresses that owning equity stock in a firm is
    the same as owing a European call option and selling a put option on
    the firm’s assets, with the price being the value of the firm’s debt.
     Therefore, as shown in the last picture, when asset value is greater
    than the debt, assets are worth more than the debt, the result is
    equivalent to the condition of “in the money” in long call option.
     When the asset value is less than the value of debt, the long call
    option is “out of money”. This is very likely to the short put option,
    only the bondholders can be repaid and long call will not be
    exercised.
     Equity holders can only exercise “call option” when it is in-the-
    money, otherwise they won’t exercise and leave the debt to
    debtholders.
    Financial article

    Martino, E. (2020). The Bail-in Beyond Unpredictability: Creditors’ Incentives and


    Market Discipline. European Business Organization Law Review, 21(4), 789-828.
    doi: 10.1007/s40804-020-00188-7
    Thank you for
    watching

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