The course  summarises  some leading models  for the pricing of credit risk and the valuation of credit derivatives.  The models  are presented  in a simplified fashion,  with examples.  The role of interest  rate risk, default risk, and recovery risk are all given play in these models.  We focus on three different pricing models: (a) Structural,  (b) Reduced-form (Intensity), and (c) Rating-based  transition  matrix models.

First, we take a look at the key credit derivative products,  their structures and related markets issues. We will then examine  the first of many models, restricting  attention to modelling approaches  which directly model the credit spread. We look at the components of the credit spread and the CDS basis in greater detail,  and then move onto an explicit  model.
We examine  in great details  the Black–Scholes option-theoretic (Moody’s–KMV) structural approach, which makes explicit  assumptions about the dynamics of a firm’s assets,  its capital structure,  its debt and shareholders. Default  risk embedded in corporate securities priced into CDS are critically  considered and analysed.  In particular, the impact on default risk and CDS prices due to changes  in dividend policy, debt- equity capital structure mix with varying seniority and refinancing schedules, investment  policy, and convertible  optionalities are examined.
We then extend the methodology  to include  stochastic term structures  with counterparty risk (reduced-form models) and credit rating transitions.

In the last section we discuss, in brief, the application of the methods  in this course  to credit portfolios. A CDO is a financial claim to the cashflows generated  by a portfolio  of debt securities or, equivalently, a basket of CDS contracts. In this way, CDOs allow redistribution of credit risk in any given portfolio  into new tranches  with risk profiles  that are different  from the underlying assets.  In this section, we clarify the basic concepts and methods for analysing structured credit transactions. We show how to determine the risk structure of CDOs both by simulation  and analytically.

This intensive 3-day course uses the theory of real options and agency contracting theory to address the management and valuation of loan portfolios and the capital structure of organisations. By attending this course you will learn:

• Leading models for the pricing of credit (default) risk and counterparty credit risk, and the valuation of credit derivatives
• Key modelling approaches for interest rate risk, default risk and recovery risk
• Powerful insights of the Black–Scholes/Merton option-theoretic
  (Moody’s–KMV ) Structural (Firm Asset Volatility) Model
• Reduced-Form (Intensity) Models
• Rating-based Transition Matrix Models
• Applications of credit risk models to credit portfolios - CDOs
  

Delegates will be able to combine theoretical teaching with practical applications with computational workshops. The focus is on the practical implications rather than the computational details.

WHO SHOULD ATTEND?

This course has been specifically designed for the benefit of:

• Financial Risk Managers
• Credit Managers
• Financial Engineers
• Financial Industry Regulators
• Auditors
• Credit Portfolio Managers
• Asset Managers
  

 

 

Registration commences at 8:30 on day one
Programme runs from 9:00 - 5:00 daily

Credit Risk and Derivaitves: Key Building Blocks

Credit Risk, Credit Derivatives and Financial Engineering

• Developing key credit risk concepts through simple example:
• Embedded derivatives (optionalities) in bank loans
• Fundamental building blocks:
  -hedging/arbitraging taxonomy
• Interest rate swaps, yield curves, and CDS’s
• Market (interest rate) risk, credit (default)
  risk, recovery risk, default correlation
• Loss given default (LGD), Exposure at default (EAD), Recovery rate (RR)
• Credit spread, default intensity, probability of LGD, expected loss (EL)
• Three-way risk classification

Credit Default Swaps (CDS): Structure, Pricing and Hedging

• CDS cashflows with default possibility
    - Decomposing defaultable risky bond 
    - Isolating underlying default risk using a single instrument
• Adding floating LIBOR-based payments
    - Credit spread over swap rates
    - True interest rate swap
• Default-free money market deposit (FRN)
    - Final adjustment to compensate coupon reduction
    - Synthetic portfolio of cashflows
• Real world complications, hedging difficulties and counterparty credit risk

Synthetic CDS: Basis Trades

• Hedging/arbitraging CDS: positive/negatives basis trades
• CDS “fair price”: asset swap ‘par’ spread price implications
• CDS key issues: OTC shortcomings, fair- value accounting

Structural (Firm Asset Volatility) Models: Simple Optionalities

Black–Scholes/Merton Option Pricing Approach

• Key credit risk (optionalities) concepts
• Bank-loan decisions and loan guarantees
• Credit (default) risk as put option
• Put-call parity theorem:
  -Tax arbitrage, accounting abitrage
  -Regulatory arbitrage, securitisation and CDOs

Computational Workshop: Synthetic

Options and Credit Spread: Case study of loan arrangements and capital structure arbitrage

Structural (Firm Asset Volatility) Models: Compound Optionalities

Black-Scholes/Merton (Firm Asset Volatility) Approach

• Embedded complexities of interim cashflows
  -Effects of dividends on default risk and CDS price
  -Effects of capital structure on default risk and CDS price
  -Effects of investments on default risk and CDS price
  -Recapitalisation effects: design of Pareto- efficient contracts

Computational Workshop: Black- Scholes/Merton Binomial Structural Model:

• Asymmetric (agency contracting) information framework
• Role of bondholders’ covenants

Black-Scholes/Merton (Moody’s- KMV) Credit Default Dynamics

• Credit risk as a function of equity value
• Cost of hedging credit (default) risk
• Term structure of credit (default) risk spread
• Distance-to-default (DD) , probability of loss given default (PD)
• Endogenous recovery value, expected shortfall
• Systematic and specific risk of default risk

Computational Workshop: Pricing

• CDSs Using Structural Models:
  -Musiela–Rutkowski/Pan first-passage model and approximation
  -Pricing the CDS premium and protection legs

Reduced-Form (Intensity and Transition) Models

Jarrow–Turnbull (JT) Reduced-Form (Intensity-Based) Model: Applying Term Structure models

• Stochastic term structure of default–free interest rates: Black–Derman–Toy (BDT) single factor model
• Stochastic maturity specific credit-risk spread
• Implementing a discrete-time Markov model
• Worked Examples:
  -Pricing credit risky bonds
  -Pricing options on credit risky bonds
  -Pricing vulnerable derivatives
  -Pricing credit default swaps (CDS)

Computational Workshop: Jarrow–Turnbull Reduced-Form Model: Pricing credit risky bonds options and CDSs using a reduced-form approach

Understanding the Jarrow–Lando–Turnbull (JLT) Rating- Based Transition Matrix Technology

• Credit ratings and default probabilities:
  - mathematics underlying the JLT model

Computational Workshop: JLT Transition Matrix Models: Pricing the Jarrow–Lando–Turnbull (JLT) Markov credit transition matrix

Collateralised Debt Obligations (CDOs)

Mechanics of CDOs

• Tranched default basket
• Tranches of protection
• Balance sheet motivated and arbitrage motivated CDOs

CDO Credit Enhancements (Credit Structures)

• Cashflow CDOS. Waterfall schedules.
• Super senior, senior, mezzanine, equity tranches

CDO Pricing

• Pricing with no correlation
• Pricing with Merton–Cholesky decomposition correlation
• Correlation trading. Implied Correlation

Summary of Course

• Dr TS Ho

  
  

  Dr. TS Ho is the managing and technical director of an educational consultancy firm based in the UK, and professorial advisor of global derivatives risk analytics and chief scientific officer at leading financial institutions. His academic positions include visiting scholar and professor of finance, and professorial research fellow at various universities.

  A recipient of the ''highly commended prize'' in the Pilkington Teaching Award and ''best teacher'' awards, he has worked with numerous leading investment banks, and has implemented risk management systems for derivative products for major financial institutions worldwide.

  He holds a doctorate in mathematical and empirical finance and has published papers on the valuation and hedging of complex derivatives, market risk, and credit risk in eminent academic journals, books and conference proceedings. He has received a number of research and educational grants for innovation in finance teaching and research. He was awarded the ANBAR citation for ''international recognition of outstanding contribution to the literature and body of knowledge''.
  

Credit Risk Modelling

Interested in holding this course in-house? Please fill out your details and a member of our team will be in touch with more information.

Retail Credit Risk and Credit Scoring

1-4 Oct 2012 (London, UK)

Sovereign Risk Analysis

20-21 Sep 2012 (London, UK)

Leveraged Loan Syndication & Distressed Debt

21-23 Nov 2012 (London, UK)

This practical 3-day training course will teach you everything you need to know about leveraged loan syndication and distressed debt and restructuring.

Syndicated Loans

26-28 Sep 2012 (London, UK)

This 3-day training course looks at structuring and pricing syndicated loans.

Corporate Credit Analysis and Financial Modelling

12-16 Nov 2012 (London, UK)

The aim of this 5 day course is to teach delegates how to analyse corporate credit risk and how to assess an appropriate return.

London School of Credit Analysis

9-13 Jul 2012 (London, UK)

During the 5 days, two of the top credit specialists will take you through the regulations, rating agencies, cashflow, debt issues, corporate loan workouts and financial restructuring.