FINS5530, - 5/26/11 03:00:39 AM FinS 5530 Financial...

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Click to edit Master subtitle style 5/26/11 03:00:39 AM FinS 5530 Financial institutionS Ilya Serov Week 3: Credit Risk
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5/26/11 03:00:40 AM Additional Sources Ø Ø Textbook, pp. 349-52 Ø A nice summary by FDIC: Ø http:// www.fdic.gov/regulations/examinations/supervis 22
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5/26/11 03:00:40 AM Agenda Ø Credit Risk: Ø Basic definitions Ø Traditional Methods of Credit Risk Measurement Ø Modern Credit Risk Management Techniques Ø Portfolio Management 33
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5/26/11 03:00:40 AM Definitions and Framework Ø What is credit risk? Ø How do measure credit risk in aggregate? Ø Return on a loan 44
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5/26/11 03:00:40 AM What is Credit Risk? Ø Credit risk is risk of loss that may occur from failure of a counterparty to meet a payment obligation as and when it falls due. Ø Two aspects of credit risk: 1. Default Risk: Ø Risk of non-payment within the given horizon 1. Mark-to-market losses: Ø Credit deterioration short of default
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5/26/11 03:00:40 AM Speculative Grade Default Rates
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5/26/11 03:00:40 AM High Yield Spreads (bps)
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5/26/11 03:00:40 AM How Do We Quantify Credit Risk? Ø What is the probability that the counterpart will not fulfill its obligations? Ø Default Probability (PD) Ø How much can we expect to get back from collateral or negotiation? Ø Recovery Rate = 1 – LGD (loss given default) Ø What is the size of any outstanding credits Ø Exposure at default
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5/26/11 03:00:40 AM Reminder: Probability Density Functions Ø When estimating the amount of economic capital needed to support FI credit risk activities, use a probability density function (PDF) of credit losses:
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5/26/11 03:00:41 AM Role of Credit Risk Models Ø A credit risk model encompasses all policies, procedures and practices used by a FI in estimating a portfolio’s PDF. Ø Consider: Ø Individual loan analysis vs. Portfolio analysis Ø Conditional vs. Unconditional models Ø Conditional: incorporate information about the state of the economy Ø Unconditional: borrower-specific information only Ø Interdependence: how correlated are various credits?
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Return on a Loan Ø Factors: Interest rate, fees, credit risk premium, collateral, and other requirements such as compensating balances and reserve requirements Ø Return = inflow/outflow Ø 1+k = 1+( of + ( BR + m ))/(1-[ b (1- RR )]) Ø Expected return: 1 +
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FINS5530, - 5/26/11 03:00:39 AM FinS 5530 Financial...

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