Counterparts Credit Risk Essay

1902 words - 8 pages

Counterparty credit risk in portfolio risk management
Prominent financial institution failures reminded market participants that over-the-counter derivatives bring counterparty credit risk. Even as these markets move towards settlement through clearing houses, significant volumes of existing and new transactions remain bilaterally settled, especially as non-standard derivatives may not qualify for central clearing. UBS Delta is providing tools for clients to measure counterparty exposure alongside other investment risk
Prudent risk management of credit portfolios includes measurement and limitation of exposure to individual issuers to manage concentration risk. Investment portfolios will ...view middle of the document...

Exposure modelling Here we use a simple example to explain exposure measures: The only trade with counterparty “MadeUpBankLtd” is a foreign exchange forward, buying EUR10m for USD, one-year forward at 1.3600. We allow (for educational purposes only) currency returns to take seven equally spaced values, with defined probabilities, as in figure 1. We calibrate the distribution ensuring that the mean price equals the forward and standard deviation of returns equals one-year volatility. For each rate we calculate the value of the trade (and thus the netting set) and from that the counterparty exposure: positive netting set value equals exposure; negative and the exposure is zero, as money is owed to the counterparty. (Note: In either case, we will lose the transaction at default. If we wish to keep the same position in EUR|USD, the trade will need replacing.) The average of these exposure numbers – expected exposure (EE) – is just over USD0.5m. EE is driven by EUR|USD and by the volatility of EUR|USD, due to asymmetry of the exposure profile. Potential future exposure (PFE), a measure of the extreme of the exposure, is just under USD3m, at the 97.5% confidence level. PFE is commonly used to limit exposure to individual counterparties. EE numbers have the advantage that, when being aggregated across netting sets (that cannot be netted together), the EEs are additive, unlike PFEs. EEs are therefore often used for portfolio level measures and limits. Sensitivities We can use this simple model to derive useful measures of sensitivity of exposure to market drivers and volatility changes. Shifting EUR|USD up by 0.01 pushes the EE up on this trade by ~USD32,000 and the exposure rises by ~USD49,000 per one point rise in volatility. Where netting sets have large numbers of market drivers, sensitivity measures are very useful, especially when volatile markets cause large exposure moves just as counterparty credit may need extra attention. Exposure profiles Performing the same exercise for different time horizons will give EE and PFE exposure profiles. Taking the second row of table A as an example, we can show the exposure profile (EE and PFE) across the maturity spectrum for this set of receive-fixed ITM swaps (see figure 2). Many risk limit frameworks use peak PFE/peak EE measures, as shown in table A.

1 An illustrative model – EE and PFE
Frequency

45%

Value of exposure

EE (expected exposure) – mean of the exposure numbers
20% 5% 20% 5%

2.5%

2.5%

PFE (potential future exposure) – maximum exposure at a certain confidence level
EUR|USD

0.8000 0.9400 1.0800 1.2200 1.3600 1.5000 1.6400 1.7800 1.9200

Buy EUR10m for USD13.6m, one-year forward (only trade with c/p)
Probability
(in one year)

2.5% 0.9945 -4.2m 0 0

5% 1.1015 -2.8m 0 0

20% 1.2200 -1.4m 0 0

45% 1.3512 0 0 0

20% 1.4965 +1.365m +$1.37m $0.27m

5% 1.6574 +2.974m +$2.97m $0.15m

2.5% 1.8356 +4.756m +$4.6m $0.12m

Rate

Trade value

Source: UBS Delta
...

Other Papers Like Counterparts Credit Risk

Risk Management Essay

4636 words - 19 pages have more volatile or even negative returns on their assets. This paper analyzes the risk management procedures of Islamic banks by giving a differential analysis of risk management discussing only the unique characteristics of risk management in Islamic Banking. The usual credit assessment procedures and BASEL are not discussed. This paper looks at the comparative performance of Islamic banks and conventional banks by using ROE as the

Shadow Banking Essay

1545 words - 7 pages themselves. RISK OR VULNERABILITY: Shadow banks, since they are not covered by the same prudential regulations as depository banks, can afford to have a relatively higher financial leverage as compared to their counterparts. So their debt to liquid assets ratio is comparatively higher as compared to the mandated numbers. So these banks can afford to fool the not so experienced investors by faking superior performance during boom times by taking pro

Co-Branding as a Tool for Customer Accquisition

3434 words - 14 pages prospects. But that's certainly not all. Co-branding has several proven, powerful benefits*, including:    Co-branded cardholders outspend their counterparts by approximately $4,900 per year. Co-branded credit cards comprise 55% of all credit card spending. Co-branded cards drive usage and preference as consumers seek to "get something back" for their business and loyalty.  Co-branded card spend is growing at a faster rate than that of

Simple Tgt Review

1071 words - 5 pages by a 2013 information breach, while simultaneously positing Target in an industry of increased competition. Drivers of Sales & Revenue Target generates its revenue through its U.S. brick and mortar retail operations and online operations via target.com. Target also generates revenue through its credit card portfolio. Target has had an agreement with TD Bank Group, since 2012, to sell all of its credit card receivables to TD. As a result, TD

Ppp and Project Financing in Logistics Infrastructure

2337 words - 10 pages limited) recourse basis, the contractual structure of the project have to be properly designed to reduce the credit risk at a reasonable level, in line with the lenders’ requirements. Considering that debt represents the largest part of the invested capital, it is sensible that lenders, and their advisors, call for substantial efforts to ensure that the risks associated with the project are reduced or eliminated as far as possible. Project

To Be or Not to Be

3774 words - 16 pages PBT growth within a robust risk management and control environment • Pro-actively monitor and report on existing credit exposures • Input into Wholesale Balance Sheet Execution strategies • Assist in the structuring and hedging of investment products and liability management instruments • Foster and develop strong working relationships both internally and externally • Cultivate and reinforce relationships with market counterparts

Pullotion

914 words - 4 pages are open to choice. Whether these procedures are necessary is solely decided by the kinds of import and export and the category of the import and export commodities. China Import Procedures Most of the import businesses in China are transacted in FOB prices. Only a very small minority of the import commodities are transacted on CIF terms. The majority of means of payment are in letter of credit (L/C). The commodity import include a series of

Csr and Its Importatnce in Your Business

852 words - 4 pages Report Israel Country Profile. May2014, p14-48. 35p. Abstract: The article presents an analysis of the political, economic, social, technological, legal and environmental (PESTLE) structure in Israel, explored on four parameters, such as current strengths, current challenges, future prospects and future risks. Topics covered include the nature of coalition politics in Israel which caused regular ideological conflicts, the risk of a mortgage

Factors That Will Be Affecting the Demand and Supply for Products

1998 words - 8 pages institutions in the next several years Supply of credit cards issued by financial institutions (like Citi Bank’s Citi Gold Credit Card) is expected to decrease over the next few years, which will make the curve shift upwards and to the left from S0 to S1. The factor at play is as follows: 1. The current turmoil in the financial industry is going to make bank’s credit risk management systems vary of sub prime and low quality consumer segments and

Lawrence Team

1885 words - 8 pages plan will result in optimizing revenue, decreasing cash borrowed turn-around time, positive business relations and maintaining positive cash balance thus reducing risk for unforeseen emergencies. Three alternative working capitals to evaluate are the maturity matching approach, the conservative approach, and the aggressive approach. Maturity Approach “With maturity matching, the firm hedges its risk by matching the maturities of its assets and

Classic Airlines Marketing

1738 words - 7 pages improve the services and kept their loyalty. The frequent flyers program is critical to measure its customer satisfaction and loyalty. By implementing the nine-step problem solving model, Classic Airlines can identify the issues, plans for solutions, recognize ethical dilemmas, and assess risk before making result evaluation to meet the end state goal. Issue and Opportunity Identification There are important issues that the management at Classic

Related Essays

Basel Norms Essay

4725 words - 19 pages the Basel I Accord. It sets a universal standard whereby 8% of a bank’s risk-weighted assets must be covered by Tier 1 and Tier 2 capital reserves. Moreover, Tier 1 capital must cover 4% of a bank’s risk-weighted assets. This ratio is seen as “minimally adequate” to protect against credit risk in deposit insurance-backed international banks in all Basel Committee member states. Pillar IV - Transitional and Implementing Agreements The

Derivatives Essay

624 words - 3 pages their returns on the investment. Derivatives market connects the local markets with the global market. The futures contracts are designed to deal directly with the credit risk involved in locking-in-prices and obtaining forward cover. These contracts can be used for hedging the price risk & discovering future prices. For commodities that compete in world or national markets, the discovering the future price or the market movement will help

Non Traditional Learners In Higher Education Essay

1160 words - 5 pages goals, a change of career, or to gain advancement in their current career. This paper will attempt to define non-traditional learners, explain some of the challenges facing them, and discuss graduation numbers of non-traditional students against their traditional counterparts. There is no exact definition of a non-traditional learner, although there are some generally agreed upon characteristics that define many non-traditional learners

American Insurance Group Essay

724 words - 3 pages employees operated in their own world as an hedge fund company of some sort. If AIG was responsible, it would have monitored and assessed the state of the economy as its counterparts abused their credit protection by recklessly selling risky mortgages, thus creating an unhealthy financial environment. Instead the corporate culture at AIG rewarded decisions that led to quick gains. In order for AIG to be profitable again, it needs to implement a