Lecture19 - 11/16/2010 MGMT 4370 / MGMT 7760 Risk...

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11/16/2010 1 MGMT 4370 / MGMT 7760 Risk Management Aparna Gupta Lally School of Management and Technology Office: PITTS 2104 Email: guptaa@rpi.edu Phone: x2757 Credit Derivatives and Securitization 2 Aparna Gupta, Lally School, RPI Credit Derivatives and Securitization –Introduction Innovation in credit-risk transfer is obviously important for banks, but actually it has significant effect in the wider world. Credit derivatives and securitization not only helps the banking industry, it is also relevant to the management of credit risks borne by leasing companies and large non- financial corporations (in the form of account receivables). For instance for producers of capital goods which often For instance, for producers of capital goods, which often provide their customers with long-term credit, long-term leases . Credit derivatives also allow non-banking institutions to participate in credit risk and get a piece of the pie of the risk- return benefit of credit risk – private and institutional investors, hedge funds, insurance companies. 3 Aparna Gupta, Lally School, RPI Credit Derivatives and Securitization –Introduction The essential idea of credit derivatives is allow spreading the risk so that the effect on a single entity is not devastating. The traditional way of controlling credit risk are – bond insurance, – collateral, – guarantees, early termination or early termination, or – selling off a portion of the loan in secondary loan market. These are mutual agreement b/w the transacting parties. – Hence customer relations and reputation can sour should things go wrong. They don’t unbundled (separate) the credit risk from the underlying positions so that it can be redistributed among a broader class of financial institutions and investors. 4 Aparna Gupta, Lally School, RPI Credit Derivatives and Securitization –Introduction Credit derivatives are off-balance-sheet arrangements that allow one party (the beneficiary) to transfer the credit risk of a reference asset to another party (the guarantor) w/o actually selling the asset This allows stripping credit risk from market risk, and transfer credit risk independently of funding and relationship management
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Lecture19 - 11/16/2010 MGMT 4370 / MGMT 7760 Risk...

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