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Three Days Introductory Course in Credit Risk Management

DAY ONE
Building Blocks

Brief Overview of the current “Sub-Prime” Triggered Financial Crisis and the Impetus of understanding / reviewing Credit Risk Management Practices



The Fundamental Building Blocks of Credit Risk:

  • Definition of Default / Credit Event
  • Default Probability
  • Exposure
  • Recovery (Loss given Default)

Key Processes inherent in Sound Credit Risk Management:

  • Credit Policies – The Role of the Credit Committee
  • Customer Segmentation
  • Accounting for Delinquent Loans (IFRS vs GAAP rules)
  • Limits Setting & Monitoring

Customer Credit Rating Models

  • A Synoptical Perspective on Internal Credit Rating Models
    • Heuristic / Expert Models
      • Classic Rating Questionnaires
      • Qualitative Systems
      • Expert Systems
      • Fuzzy Logic Systems
    • Statistical Models
      • Multi Variate Discriminant Analysis (MVA) - Altman´s Z-Score/Zeta Model
      • Regression Models: Logit and Probit
      • Artificial Neural Nets
    • Causal Models
      • Option Pricing Models (KMV – DtD Model) - Case Study
      • Cash Flow Simulation Models (regression & stochastical time series)
      • Liquidity Constraints
    • Hybrid Models
    • Criteria required by Auditors for accepting internal Rating Models
    • Models used by Rating Agencies
  • Examples of Rating Models used by key industry players
    • Retail Customers
    • Corporates
    • Financial Institutions
    • Sovereign Borrowers

DAY TWO
Components of Credit Risk

Backtesting and Validation of Credit Rating Models

  • Discriminatory Measures
    • Gini Coefficient
    • CAP Curve
    • ROC Curve
    • AUROC
    • Pietra Index
    • Bayesian Error Rate
    • CIER Index
    • Kolmogorov-Smirnov Test
  • Calibration Process
    • Brier Score
    • Reliability Diagrams
    • Calibration Backtesting
  • Dealing with Low Default Portfolios
  • Best Practice Validation Processes

Classical Components of Credit Risk Measurement

  • Estimating Default Probabilities
    • Mathematical Underpinning
    • Marginal vs. Cumulative vs. Average Default Rates
    • Transition Probabilities – Properties, Examples
    • Actuarial Estimating Methods
    • Market Implied Default Probabilities - term structure of spreads
    • Case Study on Bond Spreads: Interpretation
    • Inferring Default Likelihood from Equity Prices (Merton Model)
  • Recovery Rates and LGD
    • Statistical Estimates
    • Market Implied Recovery Rates
  • Estimating Exposure at Default
    • Current vs. Potential Exposure
    • Estimating Potential Exposure by Instrument Type
    • Time Profile of Expected Exposure
    • Case Study: Expected vs. Maximum Exposure for an Interest Rate Swap
    • Case Study: Exposure Profile for an FX Swap
  • Exposure Modifiers
    • Marking to Market (brief Discussion on IAS stipulations)
    • Margins
    • Collateral
    • Exposure Limits
    • Re-couponing
    • Netting Agreements (Gross Replacement Value vs. Net Replacement Value)
      • ISDATM master netting agreements
      • Basel II & Regulatory recognition
    • Credit Triggers
    • Time Puts

DAY THREE
Risk Mitigation and Capital Allocation Models

Overview of Credit Products:

  • Cash Products (loans & bonds incl the syndicated & leveraged loan market)
  • Credit Derivative Products
    • Credit Default Swaps
      • First (of Basket) to Default
      • Nth to Default
      • CDS Indices
    • Total Rate of Return Swaps
    • Credit Spread Forward Options
    • Credit Spreads Options Contracts
  • Pricing and Hedging Credit Derivatives
    • Actuarial Approach
    • Spread Methods
    • Equity Pricing Methods
    • Examples
  • Structured Credit Products
    • Credit Linked Notes
    • Collateral Debt Obligations „CDOs“
      • Balance Sheet vs. Arbitrage CDOs
      • Cash Flow „funded“ vs. Synthetic CDOs
      • Managed vs Static CDOs
      • Market Value CDOs
      • Other CDO related Structures
        • CDO squared
        • CDOs on ABS
        • CDOs on CDOs
        • CPDOs „Constant Proportional Debt Obligations“
    • Pricing Structured Products
      • Synthetic CDOs
        • Generating Portfolio Loss Distributions - Conditional Survival Probabilities
          • Demistifying Copulas
          • Backtesting Default Correlations - Discussion
        • Pricing a Tranche given the “unconditional“ Loss Distribution
          • Value of the “Contingent Leg”
          • Value of the “Fee Leg“
        • Deriving Implied Correlations
      • Cash CDOs
        • The Asset Side
        • The Liability Side

Credit Portfolio Models

  • Measuring Credit VAR
  • CreditMetricsTM
  • CreditRisk+TM
  • Moody´s KMV Credit MonitorTM
  • CreditPortfolioViewTM

Fitting it all together - RAROC Models

  • Integrated Risk Management - Capital Allocation
  • The Decision Process in the Credit Committee
  • Incremental RAROC
  • Marginal RAROC
  • Regulatory Constraints (brief overview of Basel I vs. Basel II)

Off Balance Sheet Vehicles

  • Conduit Structures
  • SIVs
  • Accounting Treatment

Lessons to be learned for Risk Managers and Credit Analysts from the Financial Crisis



Conclusions and Discussions