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If a loss occurs the funds in the escrow account are

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If a loss occurs , the funds in the escrow account are transferred to the protection buyer , and the investors forego some or all of their principal . Where no money event occurs (absent), the money is used to make principal payments , to pay back the security holders . These transactions remove the counterparty credit risk associated with the transfer of another form of risk , but not all counterparty risk is eliminated from these transactions. The advantage of this technique is that it allows protection buyers access to alternative markets populated by investors like hedge funds who are comfortable in taking unusual risks in exchange for a high expected return .
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Topic 8 – Credit Portfolio Management 1. How does Level 1 of Credit Portfolio Management meet the objective of limiting concentration risk, hence reducing risk in the aggregate? Level 1 Techniques Aggregation: Measuring the accumulation of risk for each counterparty to manage a portfolio of credit exposures. Reporting: Provide frequent and regular updates on the content of the credit portfolio. Credit Limit: Setting an absolute amount of exposure. Surveillance: Monitoring the performance of the transaction and counterpart after the deal has been closed. Mitigation: Transfer credit risk exposures to other firms. Managing a portfolio of credit exposures starts with measuring the accumulation of risk for each counterparty (Aggregation), that is, measuring the accumulation of risk across multiple transactions on a counterparty-by-counterparty basis. Level 1 requires identifying all companies that are related and how they are related. The focus is on the prudent risk taking via strict limits, on the knowledge of the composition of the portfolio and on the monitoring of its performance objective of limiting concentration risk. 2. How does Level 2 differ from Level 1? Level 1 CPM Level 2 CPM Focus: Simply to reduce credit risk in the aggregate. Requires More: Common Sense Well Managed Organisation Skilled People Does Not Require: Large Infrastructure Focus: Amount of capital at risk and on profitability. Requires More: Analytical Skills Analytical Tools Larger companies such as Insurance, Commodities Trading Companies and Major Financial Institutions Because large unexpected losses occur in any portfolio and current period profits are insufficient to absorb them, a cushion has to be built in order to protect the firm against the risk of insolvency. With Level 1 it was difficult to quantity the amount of losses that could occur because of constraints on computations power and access to data . Thus, it was difficult to size the amount of capital to set aside to cover such losses . Hence, Level 2 develop the quantitative methods and more feasible to perform this sizing . As a result, after calculating the amount of capital at risk at the portfolio level , it is possible to allocate the aggregate amount to individual transactions .
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3. Level 3 manages the Risk-Management Function as a profit centre, expand on this notion within a transfer pricing context.
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  • Fall '19
  • Debt, Bill Ramsey

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