Default and Credit Migration by Edu Pristine

Author of lecture Default and Credit Migration

Edu Pristine

Customer reviews

Excerpts from the accompanying material

... able to: define and discuss default probabilities and term structures of default rates, define credit ratings, demonstrate measurement of rating accuracy, describe the methodology ...

... that might be used to assign PD to corporate and retail borrowers. These include: internal rating models - proprietary to a bank, external rating by credit rating agencies like S&P, Fitch and Moodys’ ...

... Default probability: probability of an event occurring. Survival probability: probability of an ...

... in each year for BBB-rated corporate bond is 0.5 %, 0.3 % and 0.27 % respectively. A = 0.2692 %, B = 0.3155 %, C = 0.1754 %, D = 0.5114 %. Solution: A. The cumulative default probability at end of three years = (probability of survivor in 1st year) * (probability of survivor ...

... country, business parameters and behavioral (past conduct with the bank) performance. External ratings: Rating agencies like S&P, Moodys’ and Fitch assign ratings to instruments (bonds, preference shares, fixed deposits, pool of retail assets etc.), corporates, securitization exposures, ...

... rating system is the one that produces the ‘true’ default probability. Unfortunately, the concept of the ‘true’ default probability is very elusive: it depends on the information that is available, and it has no direct relation to observable ...

... x% worst obligors according to the model’s ranking. The other extreme is a ‘random’ model in which the obligors are ranked completely at random, without any reference to their actual credit quality. With such an approach, we can expect to find 50 % of the actual defaulters in the 50 % (randomly chosen) ‘worst’ obligors, 10 % of the actual ...

... instruments, in terms of their credit quality and their ability to pay their investors. This analysis is summarised in a rating classification into one of several rating classes: Aaa to C for Moody’s, and AAA to C for Standard and Poor’s and Fitch. Agency rating classifications are publicly available and are an important factor driving the decisions of ...

... regarded as investment-grade. Besides the classical, ‘fundamental’ ratings, quantitative credit rating providers have more recently entered the market using proprietary quantitative statistical models to produce an output which can be more directly interpreted as a ‘probability of default’. ...

... Over the period of one year:-BBB rated bond has the probability of moving up to AAA bond of 0.06 %. The same BBB bond has the ...

... Working capital/Total Assets X1: 35.4 % - 11 %. Retained earnings/Total Assets X2: 42.8 % - 58.4 %. EBIT/Total Assets X3: 18.4 % - 29.4 %. Market Capitalization/Debt X4: 182.3 % - 29.8 %. Sales/Total Assets: X5 220 % - 120 %. Altman used Discriminant ...

... by the business through earnings retained by the business over the years. Higher value is associates with better credit worthiness. Earnings before interest and taxes. Total Assets (X3): A measure of profitability and return on assets. Market capitalization/Debt (X4): Inverse of Debt: Equity, but ...

... × X1 + 1.4 × X2 +3.3 × X3 + 0.6 × X4 + 1 × X5 (no need to remember the equation). Higher the Z-score, better ...

... higher score in probit model is associated with higher PD. Logit: Similar to Probit model, except that scores are mapped to PD using a logistic transformation rather than cumulative normal distribution function. ...

... a perfectly adequate model to price simple credit-sensitive instruments such as corporate bonds or credit default swaps (CDSs), provided that the necessary conditional default probabilities ...

... instruments are subject to the same type of credit risk, that is, they reference the same obligor and they have the same recovery rate and seniority class in default. We use the risk-neutral pricing paradigm, that is, we ...

... corporate bond is 2.1 % and the contribution of non-credit factors is 0.78 %. If the recovery rate in case of default is 35 % calculate the ...

... can narrow as it approaches maturity as there is a greater chance that it will be repaid. As interest rate increases, expected firm value at maturity increases which in turn decreases ...

... corporate bonds of 0.65 %, which will yield an implied default hazard rate of 1.08 % (assuming a recovery rate of 40 %). This spread is measured as spread over Aaa-rated corporate bonds and not as spread over treasuries (in order to avoid tax and liquidity premia, which would be present in the treasury market). The spread is ...

... in 1997/8 The blue line tells us that over 1997–2000 the annual default rate of the ‘Baa97’ bond portfolio was only 0.3 %. This is still much less than the implied default rate, and even less than the spread. Even over a five-year horizon starting 1997 the historical default rate is only about 0.55 % p.a., much below the implied ...