CHap 7 IMD (mixte)
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Questions and Answers

What does a high amount of borrowing encourage in a borrower?

  • Risky behavior (correct)
  • Increased financial responsibility
  • Improved credit ratings
  • More cautious spending

    • Credit risk is considered less important than operational risk for companies and financial institutions.

    False

    Name one manifestation of credit risk.

    Counterparty default

    The size of the loan affects the __________ of the loan.

    <p>riskiness</p> Signup and view all the answers

    Match the following expressions with their explanations:

    <p>Counterparty default = Failure to meet obligations on a loan Change in the rating of the underlying asset = Alteration in perceived asset value Change in the rating of the issuer = Modification in creditworthiness of the issuer Variation of the signature spread = Fluctuation in bond margin</p> Signup and view all the answers

    What is a credit default swap (CDS)?

    <p>A contract that pays upon the occurrence of a credit event</p> Signup and view all the answers

    A credit event must always be a price change.

    <p>False</p> Signup and view all the answers

    What happens to the payment of the protection buyer in the event of default?

    <p>The payment is suspended.</p> Signup and view all the answers

    What does the term 'attachment point' refer to in a CDS tranche?

    <p>The minimum loss threshold</p> Signup and view all the answers

    A credit event may include a default on ______ or interest.

    <p>payment</p> Signup and view all the answers

    A Senior CDS Basket covers losses incurred by a portfolio up to a certain amount.

    <p>False</p> Signup and view all the answers

    Match the following credit events with their definitions:

    <p>Default on payment = Failure to pay principal or interest Bankruptcy = Inability to meet debt obligations Restructuring of debt = Modification of terms of an existing obligation Moratorium = Delay in payment of debts</p> Signup and view all the answers

    What is the primary function of the CDX indices?

    <p>To represent North American companies and Emerging Markets.</p> Signup and view all the answers

    What does the premium of a CDS on a bond represent?

    <p>The risk of default associated with the bond</p> Signup and view all the answers

    The _______________ point is the threshold at which compensation begins for losses in a tranche.

    <p>attachment</p> Signup and view all the answers

    What is the purpose of the tranches on index?

    <p>To form expectations about default correlations</p> Signup and view all the answers

    The premium of a CDS must be greater than the credit spread of the underlying bond.

    <p>False</p> Signup and view all the answers

    What financial events led to the standardization of the credit event process by ISDA?

    <p>Defaults of Russia and Argentina.</p> Signup and view all the answers

    The premium for a tranche is calculated based on the difference between the detachment point and the attachment point.

    <p>True</p> Signup and view all the answers

    At what threshold the tranche mentioned in the example ceases to exist?

    <p>EUR 42 M</p> Signup and view all the answers

    Match the indices with their respective regions:

    <p>CDX = Emerging Markets Itraxx = Rest of the world</p> Signup and view all the answers

    What is the coupon rate paid by the Bank to the pension fund each semester?

    <p>5%</p> Signup and view all the answers

    What type of risk does a cash account help to mitigate?

    <p>Delinquency risk</p> Signup and view all the answers

    The Fund pays a premium of Euribor 6M minus a margin of 80 bp to the Bank.

    <p>False</p> Signup and view all the answers

    Seller's guarantees are only available in cash.

    <p>False</p> Signup and view all the answers

    What is the purpose of a Composite Swap?

    <p>A synthetic investment on a foreign index with currency risk exposure.</p> Signup and view all the answers

    What is one mechanism used to address currency risk?

    <p>Swaps</p> Signup and view all the answers

    In a standard swap, a synthetic investment is created in a __________ index.

    <p>local</p> Signup and view all the answers

    Which of the following statements about total return swaps is correct?

    <p>Standard Swaps allow for synthetic investments in local indices.</p> Signup and view all the answers

    A _____ rating needs a reserve of 8%.

    <p>AAA</p> Signup and view all the answers

    What is an example of credit enhancement?

    <p>Cash reserves</p> Signup and view all the answers

    What is the EURIBOR 6M premium paid by the Fund to the Bank?

    <p>Euribor 6M + 80 bp</p> Signup and view all the answers

    Match the following terms with their definitions:

    <p>Standard Swap = Creates a synthetic investment in a local index Composite Swap = Synthetic investment on a foreign index with currency risk Euribor = Interest rate benchmark Coupon = Periodic payment to bondholders</p> Signup and view all the answers

    Match the following ratings with their required reserves:

    <p>BBB = 0.75% A = 3% AA = 5% AAA = 8%</p> Signup and view all the answers

    Interest Rate Swaps are used to manage currency risk.

    <p>False</p> Signup and view all the answers

    The Fund experiences a loss on securities paid to the Bank as part of the __________.

    <p>premium</p> Signup and view all the answers

    What is the value of the asset pool mentioned?

    <p>€1,000</p> Signup and view all the answers

    What is a primary risk associated with a mortgage-backed security (MBS)?

    <p>Interest rate risk</p> Signup and view all the answers

    Delinquency refers to a situation where mortgage payments are made regularly on time.

    <p>False</p> Signup and view all the answers

    Name one type of risk related to the asset pool of mortgage-backed securities.

    <p>Credit risk</p> Signup and view all the answers

    A fixed-rate mortgage portfolio typically consists of repayments made in __________.

    <p>constant annuities</p> Signup and view all the answers

    Match the following risks related to mortgage-backed securities with their descriptions:

    <p>Credit risk = Delinquency and default Interest rate risk = Maturity mismatch and prepayment risk Currency risk = Effects of exchange rate fluctuations Liquidity risk = Difficulty in selling the asset quickly</p> Signup and view all the answers

    What happens when interest rates decline in relation to mortgage-backed securities?

    <p>More borrowers might refinance their mortgages.</p> Signup and view all the answers

    Prepayment risk occurs when borrowers pay off their loans early, which can harm MBS holders.

    <p>True</p> Signup and view all the answers

    What is the simplest structure of a mortgage-backed security?

    <p>Mortgage pass-through</p> Signup and view all the answers

    Study Notes

    Credit Risk and Management

    • Credit risk is a significant concern in the banking industry
    • Measurement and management of credit risk are crucial
    • Derivative instruments are used for managing credit risk

    Major Categories of Risk

    • Market risk
    • Liquidity risk
    • Operational risk
    • Credit risk

    Main Sources of Vulnerability to Credit Risk

    • Macroeconomic risks
    • Credit growth
    • Valuation of credit risk (liquidity premium)
    • The potential risk
    • The growing risk

    Credit Risk: Definition and Measurement

    • A debt is paid based on an interest rate
    • This compensates the lender for the loss of liquid assets
    • The cost of money increases with the loan term
    • The risk-free interest rate (r) represents the return on safe investments
    • Government securities are often used as a benchmark for risk-free returns

    The Extent of Credit Risk

    • The magnitude increases proportionally with the amount of debt
    • Today, credit risk is the most significant risk for corporations and financial institutions.

    Manifestations of Credit Risk

    • Counterparty default
    • Change in rating of the underlying asset
    • Change in rating of the issuer
    • Variation in the spread of the signature

    Rating Agencies

    • Rating agencies assess credit risk by assigning ratings
    • This reduces information asymmetry between borrowers and lenders
    • Major rating agencies include Standard & Poor's, Moody's, and Fitch Ratings

    Ratings on Long-Term Securities

    • Ratings are used to categorize the level of creditworthiness.
    • Ratings are applied to debt instruments to gauge credit risk.
    • Rating agencies like S&P, Moody's, and Fitch use letter ratings like AAA, AA, A, BBB to classify the instruments

    Expected Loss

    • Calculation of expected loss considers the probability of defaulting on a borrowed amount
    • The calculation is done for various time horizons, for example, one year or two years.
    • Actuarial and risk-neutral valuation methods are used to calculate expected loss.

    Credit Derivatives

    • A financial instrument whose cash flows depend on the issuer's credit quality
    • These instruments include credit default swaps (CDS) and instruments based on credit spreads
    • CDS are used to hedge credit risk exposure
    • Strategies can include hedging, portfolio management, investment, and speculation

    Securitization

    • Securitization is a financial technique where assets are pooled to create new securities
    • The process allows the issuing of new securities with periodic repayments
    • This enables the conversion of illiquid assets into liquid ones
    • The process involved creating a new legal entity (SPV) to hold the assets
    • Then, debt securities are issued to investors
    • A variety of assets can be securitized, such as real estate loans, business loans, and other receivables
    • Securitization can have different motivations like obtaining access to financial markets or lowering the risk-weighted assets
    • There are various types of structures and players involved, including legal constraints

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    Related Documents

    Credit Risk & Management Through Derivatives PDF

    Description

    This quiz explores the essential concepts of credit risk and its management within the banking sector. It covers measurement techniques, major categories of risk, and the sources of vulnerability associated with credit risk. Test your understanding of how derivative instruments can mitigate these risks.

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