Slides Week 12 - Unit revision and exam tips.pptx

A new type of ci is political risk insurance 80

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A new type of CI is political-risk insurance 80
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Surety bonds ( 履约保证) Most common in the construction and real estate industries and in doing business with government entities. Principal families of bonds: Contract bonds: Mainly cover an obligation of a construction company at different stages of a construction project, for example, bid bonds, performance bonds, and advance payment bonds. Commercial bonds: Main use is to guarantee a legal or financial obligation, for example, court bonds. 81
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Letters of credit (LCs) A written commitment by a bank to make a payment to a third party when the bank’s client requests it or when the third party requests it. They provide a financial backstop. They enhance the credit quality of a counterparty by having a strong financial institution behind the counterparty should it fail to perform. The wording is clear, standardised and well tested. 82
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LCs Irrevocable ( 不可改变) Standby Evergreen (经久不衰) 83
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LCs in Trade Finance 84
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LCs versus Surety Bonds LCs utilize language that is clearer, more standard, and stronger than a surety bonds, and beneficiaries feel more secure with LCs. BUT: Banks have limited credit capacity i.e. LCs compete with loans; LCs are expensive; LCs are easily drawn by beneficiaries. 85
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Collateral assets must meet basic criteria to mitigate credit risk. List and discuss such criteria . Credit quality: Collateral must have high credit quality. The collateral received to mitigate counterparty credit risk cannot pose credit risk in its own right. Liquidity: Collateral must be liquid; that is to say, it can be sold easily. If a counterparty defaults, the trades are liquidated and the collateral assets are sold to maximize the amount of money recovered. Price stability: Collateral must have price stability. If the collateral’s price is volatile, the price movement between two valuation dates can cause losses. Correlation: Collateral must be uncorrelated with the transaction. To be effective, collateral must not be correlated either with the counterparty or with the underlying product. Security interest: The party must have a perfected security interest in the collateral. The right to truly own and liquidate the collateral in a default scenario must be conveyed to the party that receives it. 86
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Uses of CDS Protection of a credit exposure Investment in credit: Long Credit Speculation in credit: Shorting Credit 87
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Uses of CDS Protection of a credit exposure Investment in credit: Long Credit Speculation in credit: Shorting Credit 88
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CDS as hedge A CDS contract can be used as a hedge or insurance policy against the default of a bond or loan. An individual or company that is exposed to a lot of credit risk can shift some of that risk by buying protection in a CDS contract. This may be preferable to selling the security outright if the investor wants to reduce exposure and not eliminate it, avoid taking a tax hit, or just eliminate exposure for a certain period of time. 89
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Hedge Example An investor who holds a long position in a corporate bond may wish to protect itself against the possibility that the issuer will default on its debt obligations. By purchasing a CDS, the investor can obtain protection against an increase in the issuer’s default risk. In effect, the investor uses the CDS to transfer some of the risk involved in holding the bond to the issuer of the CDS.
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  • Fall '19
  • Collateralized debt obligation, Credit default swap

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