Professional Documents
Culture Documents
4th ADVANCE
COURSE: ADVANCED TOPICS IN FINANCE
NAME: JUAN VLADIMIR SANCHEZ ACOSTA
PROFESSOR: EDMUNDO LIZARZABURU
2014
INDEX
Credit Risk
1. World history of credit
2. Introduction to credit risk
2.1.-Credit risk vs. Market risk
2.2.-Lenders
2.3.-Borrowers
2.4.-characteristics of credit products
2.4.1. - maturity
2.5.2.-specification of legal tender
2, 4, 3.-destination
2, 4, 4.-source of payments for repayment
2, 4, 5.-warranty requirements
2, 4, 6.-covenants required
2.4.7.-system characteristics amortization
3. - Banking credit risk
4. - Elements of Credit
4.1.2.1 Loans
4.1.2.4.1 Forwards
4.1.2.4.4 Swaps
4.2 Debtors
5.-Credit scoring
7. - 5 C of credit
8.- Conclusions
9. Bibliographic references
Throughout the entire evolution of credit risk and since its inception, the
concept of analysis and criteria used were as follows: since the beginning of
1930, the key analysis tool has been the balance. In early 1952, the analysis of
the income statements were changed, what mattered most were the profits of
the company. From 1952 to modern times, the criterion used was the cash flow.
Credit is given if a client generates sufficient cash to pay, since the credits are
not paid utility or inventories or less with good intentions, are paid cash.
The credit analysis is considered an art, as there is no rigid schemes and
instead is dynamic and requires creativity from the Official Credit or Business.
However, it is important to master the various techniques of credit analysis and
supplement it with a good deal of experience and judgment, so it is necessary
to have the necessary and sufficient information to enable us to minimize the
number of unknowns to be able to make the right choice.
2. Introduction to Credit Risk
Before making, any comment on it is necessary to know the variable and the
concept of risk involved and with which lived from day to day in a financial
institution
In very simple terms, there is risk in any situation where you do not know
exactly what will happen to the future. Risk is synonymous with uncertainty; it
is difficult to predict what will happen in the future.
It is therefore important to know the risk in the financial sector; most significant
financial decisions are based on predicting the future and not based on what
was expected, in that case will have made a bad decision.
There are people who refuse to accept the risks and those who are not so
reluctant, in all cases; the idea is to assume the least possible risk to the extent
of the possibilities.
However, it is good to know that the risk is not always bad; you can live with
through an incentive. Is be able to accept more risk to the extent that this is
paid (reward). That is why there is a direct relationship between risk and return,
which is why the relationship to higher risk, higher return is met.
In a previous analysis phase should be measured and rate the risk, that,
analyzing and evaluating contingencies, quantifying which will assume the
client and what assessment has the same, assigning risk limits.
This management and risk analysis models, which are reaching ever-higher
degree of automation will apply. In this process of analyzing the credit
manager's solvency must be in contact not only with the financial department,
but also with the sales department, it must be noted that a sale is not
perfected until the time of collection, implying a coordination between the two
departments to seek agreements with customers, adequate coverage,
compliance with the limits assigned risk exceeded authorizations, etc.
To get to set a limit of risk, which is simply the result of the analysis must take
into account aspects such as:
Customer Rating
relevant in the analysis and risk assessment and weighting each of them, and
finally pool risks rated in homogeneous classes, segmenting the population into
groups of similar rating.
Once properly valued and weighted the variables according to the standard
test taken, and made the appropriate adjustments in coordination with the
sales department, the risk limit of the customer will be given by the maximum
economic smashing that may result in the company will be set.
New technologies applied to this field greatly facilitate the activity manager
allowing the automation of repetitive processes and enabling the allocation of
risk limits per customer in a reliable manner.
Both credit and market risk models use historical data, forward looking models
and behavioral models to assess risks.
2.2.-Lenders
The banks provide financial intermediation, the process by which a group that
needs capital borrows funds from another group that has excess capital
available to invest. In organizing this transfer of capital between the two
groups, the bank uses deposits to fund the credit. Thus, mediation is a critical
Investment Banks
Investment banks often play the role of agent or financial intermediary firms.
Although they can make their own trading, providing investment advice to their
customers and grant loans to corporate customers, its main activity is to
organize the financing of equity and debt. Loans, bonds and other credit-on
behalf of their corporate clients.
Investment banks normally do not accept customer deposits, or extend credit
to retail customers, and in most cases, are not directly governed by bank
regulators.
Rating agencies assess the creditworthiness of borrowers and the listed debt
and credit ratings allocated to the borrowers and debt instruments issued. The
ratings are intended to provide an independent assessment of the general
creditworthiness of a borrower, based on a wide variety of risk factors.
Qualifications vary from the taller usually AAA credit rating or Aaa, indicating a
very high ability to repay the credit-to lower-rated - usually C or D, suggesting
that the bonus will not be paid or already was default- ratings investment
grade typically cover of AAA / Aaa to BBB / Baa and ratings with noninvestment grade are generally in the range of BB / Ba and C / D.
Grades with a Single-rating as AAA, BB and C - representing synthesis material
including quantitative, qualitative and legal information about the borrower
data, and communicate the results of the rating process to the public.
2.3.-Borrowers
Both retail and wholesale banks, differentiate between different types of
borrowers based on a variety of factors, including the size and financial needs.
On the retail side, clearly differentiates between individual lenders and small
business borrowers. In the wholesaler part, however, the differentiation tends
to be more complex.
Retail borrowers
Retail borrowers include consumers (individuals) who borrow money to buy
homes, cars and other goods. Generally, consumers with a high income, low
debt levels and consistent record of repayment of loans, borrowers are
considered lower risk, but the score of a borrower, ultimately, depends on a
variety of criteria.
In today's banking environment, retail banking has become similar to the
commodity business. Most banks currently grouped its retail borrowers in
relatively homogeneous risk groups based on standardized criteria.
This process enables banks to analyze characteristics and unpaid refund based
on standardized characteristics of borrowers. One aspect of this process is the
credit score (scoring), which lets you group and analyze the common
characteristics of loans and borrowers.
Corporate borrowers
Corporate borrowers include businesses ranging from small local businesses to
large global corporations. Each has different financial needs, and each must be
analyzed separately.
Depending on the ease of access to capital (regulated markets, banks, private
funding). Companies can borrow capital or increase its own resources to
finance growth and income. When they borrow, companies typically return their
obligations with cash generated by growth.
Local companies: These companies are commonly known as small and
medium enterprises (SMEs). SMEs are usually minor, such corporate entities as
corporations, family businesses, businesses owned and other small businesses.
SMEs are usually privately owned and have a simple structure. Annual sales are
usually below $ 1 million, EUR GBP 750,000 or 500,000, but the size of
business varies between institutions and regulatory frameworks for action
Regional Enterprises: regional commercial business companies are normally
larger SMEs and include franchises, gas stations and restaurants with sales
between USD 1 million and USD 100 million. Some fall under the definition of
SMEs according to Basel II. In addition their business normally exposed to one
or more local markets or cause them an overview within a region. The legal
structure and property of these business can be more complex, with multiple
owners, multiple subsidiaries and located in different legal jurisdictions.
International Business: international companies operate in more than one
country, but generally limit their activities to a certain geographic region.
Companies can be listed on a stock exchange, or otherwise, or may be big
business, private property that they operate in several countries. International
companies may have large annual sales (normally billion) and will need to
regularly receive credit by banks to maintain their activities and growth.
Global companies: these companies are generally considered as global
conglomerates with exhibitions worldwide. Normally manage their permanently
keeping abreast of global trade pressures and business issues. Most traded on
a stock exchange.
Sovereign borrowers
Sovereign borrowers are governments that raise capital through bonds or
directly receive credit, usually the world's largest banks. The amounts
generated are often used for large infrastructure investments (improved roads,
railway lines) or to finance public spending.
Governments use tax revenue to repay these loans. Overall rating agencies
rate the sovereign borrowers like any other debtor. The credit rating of
sovereign borrowers including their ability to manage internal and global
changes affecting the economy, politics, interest rate and commodity.
Public borrowers
Public borrowers are primarily state, provincial and local (municipal)
governments and their subordinate entities (for example, water and sewage
fees, airport authorities, public hospitals and school districts).
Amounts taken to credit these levels are typically used for investments (road
maintenance, water supply) or overhead. Since most local governments have
the ability to generate cash through taxation of taxpayers, public loans are
considered relatively low risk.
2.4.-characteristics of credit products
There is a wide variety of types of credit. All were developed to meet specific
needs arising from the unique circumstances of different borrowers. To find out
which type of credit operation is most appropriate for a borrower, lenders must
know the details of the borrower's financial situation, especially as it relates to
the present and future conditions in local, regional or international markets.
2.4.1. Maturity
The credit requirements vary between different time periods, with loans to
meet those needs usually classified by maturity. The maturity simply means
the date that has been making the last payment of the loan or other financial
product. For example, a loan with a maturity of one year should be returned for
a full year.
2. 4.6-covenants required
that the bank's exposure on loans is never so significant that it would affect
operations if a worst-case scenario of multiple defaults occurs. These managers
must also be aware that loans are often very profitable for banks, which make
money from interest payments, so they must be ready to assume some degree
of acceptable risk as the price of doing business.
The best method of managing bank credit risk is to keep close tabs on the
individuals or institutions to which a bank might be compelled to lend money.
Credit ratings are one way to measure the reliability of borrowers. If a borrower
has a particularly troublesome credit rating, a bank would likely pass on
offering a loan to this individual, or it would only do so at terms that are
extremely favorable to the bank.
Another method available to banks when attempting to lessen bank credit risk
is insurance. This is a wise strategy when the bank issues a loan so large that it
would cause serious problems if the borrower does not make repayment. If
there is no way to secure such a loan with collateral, an insurance policy that
covers the bank in case of default can help to mitigate the damage done if
repayment is never made.
4.- Elements of Credit
The main elements of which depends on the credit risk of the asset are
financial and debtor. Both factors influence the values presented by
fundamental variables in measuring credit risk, being instrumental in same.
4.1 Financial Assets
Financial assets can be defined as "securities issued by economic spending
units, which are a means of maintaining wealth for those who own and a
liability to those who generate"
4.1.1 Illiquid assets
Liquidity is one of the characteristics of financial assets-along with and the riskreturn, which depends on the ease with which they can be converted into cash
easily, quickly and without significant loss of value form. Financial assets may
have varying degrees of liquidity. However,
when this feature is used as classification criteria are often distinguished two
categories, which correspond to the extreme cases can occur, which are:
1. Liquid financial assets, which are characterized by a high degree of liquidity
provided by secondary trading on financial markets characterized, in turn, to be
large, flexible and deep. These financial assets are essentially the most traded
organized secondary markets, including equity that traded on the stock
exchanges.
2 Illiquid financial assets, which are those that are characterized by either
illiquid because they are not traded on any financial market secondary, or their
liquidity is reduced, which is mainly due to
traded on secondary markets that lack the characteristics of breadth, depth
and flexibility.
The degree of liquidity of a financial asset depends on:
1 The characteristics of the financial market where trades.
The liquidity of the asset will be lower the lower the trading volume that exist
in the financial market in question. Lower trading volumes may result in a
situation cyclical, such as an economic or financial crisis; or may be the result
of a structural situation that produced the financial market lacks the breadth,
depth and flexibility needed for financial assets that are traded in the liquid.
2 The characteristics of the financial asset.
Thus, there is a direct relationship between the degree of liquidity a financial
asset, which is linked, in turn, with the financial market in emitted or negotiates
the financial asset, so that assets are issued or traded in organized financial
markets.
Assets are established by the clearing house, they are more liquid than those
not issued or traded in organized financial markets, in which establish the
characteristics of the active buyer and seller mutually agreement.
The main implications of the lack of liquidity of financial assets has for
measuring credit risk are the following three:
credit institution, in which case the loan is bank called and documented in a
contract called loan policy.
Additionally, borrowers may be private companies or households belong to the
public sector.
Loans, unless the accused, are often negotiated directly in the markets
financial side, and form part of the portfolio investment entities bank, which
usually keep them in their economic structure to its maturity and valued using
the book value.
4.1.2.2 Lines of Credit
A line of credit, or just crdito12, is an operation in which a part - originatorcalled undertakes to transfer to another property cessionary- -called economic
to a limit which can be predetermined or not, while the other part agrees to
return such goods according to the agreed conditions.
Depending on the nature of the assignor, credit lines can be classified into two
following types:
1. Commercial lines of credit, where the transferor is a company generally that
no financial grants its customers a deferment in payment of goods delivering or
services provided, giving rise to what is in the field credit company called
providers.
Although less common than supplier credit, lines of credit .They can also be
delivered to customers when a specific company amount of money on account
of purchases of goods or provision of services expect to obtain in the future,
giving rise to what in business is called customer advances. In this case the
company is the assignee and the customer is the originator.
2. Bank credit lines, in which the transferor is a bank and the transferee is any
other trader.
These lines of credit are rendering financial operations and consideration
composite in which the bank agrees to make available to its customer sums up
2 The regulations governing the operation of financial markets may limit the
may experience variation from one session to another asset prices financial, in
order to limit the maximum loss that may experience the agents operating in
the financial markets or, at least, ensure that such losses gradually.
The unorganized financial markets lack these mechanisms and effective result
obtained by each party of the financial asset depends on the creditworthiness
of the other, so both are exposed to credit risk each of its counterpart.
Derivative financial assets are formalized in contracts arising rights and
obligations for both parties, and can be classified according to several criteria
among which, on the one hand, the rights and obligations provided in the
contracts and other financial markets where these are issued and traded
financial assets.
These assets are discussed in greater detail than other financial assets exposed
to credit risk because the valuation methodology of a kind-the optionsderivative financial assets used in a class of models for measuring credit risk.
4.1.2.4.1 Forwards
A forward contract is a derivative financial asset that is issued and traded in an
unorganized financial market, in which an agreement to buy or sell a real asset
or financial -called underlying asset is established, for a price -called
predetermined forward price or forward- at a future date.
The buyer of a forward contract is obligated to buy the underlying asset at the
conditions specified therein, obtaining a result that is equal to the flow.
Net cash produced by the contract delivery date, which is the difference
between the price that owns the underlying asset in the spot market on this
date and the forward price. This result is given by the following expression:
Rc t Pt F
Where:
- () C R t is the result obtained by the purchaser of the forward contract on the
date of delivery, represented by t.
- P (t) is the price of the underlying asset in the spot market on the date of
delivery.
- F is the forward price or forward. The buyer of a forward contract has a
bullish profile losses and gains can be represented by the following graph:
Figure 1.1: Profile of profit and loss of a buyer
forward contract.
Rv (t) = F - P (t)
Being
() V R t the result obtained by the seller of the forward contract on the date of
delivery.
The seller of a forward contract has a bearish profile losses and gains can be
represented by the following graph:
Figure 1.2: Profile of gains and losses from the seller of a
forward contract.
The sum of the results obtained by agents that enter into a forward contract is
zero. This is because both results are symmetrical about the horizontal axis,
what in the event that the buyer of the forward for a gain, its equals the
amount of the loss experienced by the seller and vice versa, being a zero-sum
game.
4.1.2.4.2 Future Contracts
A futures contract is a derivative financial asset that is issued and traded in an
organized financial market and which is an agreement to buy or selling a real
asset or financial subyacente- -called for a fixed price - future-denominated
price at a future date (called the delivery date).
As shown, the contracts are issued and traded in markets financial
unorganized, while futures contracts are issued and traded in organized
financial markets.
4.1.2.4.3 Options Contracts
An option contract is an agreement by which one party, the buyer, acquires,
through payment of a premium, the right to buy or sell a real asset or Financial
-active subyacente-, for money at a fixed price of exercising the option- in or to
the underlying at the price established in the option asset will be impaired by
the exercise thereof and not run, obtaining a net cash flow equal zero.
Regardless of what the value of the underlying asset, the expression that
allows obtain the net cash flow that gets the buyer of a call option is:
FNCC (t) = max [P (t) - PE, 0]
Where:
- FNCC (t) is the net cash flow that the buyer of the option on the date gets
exercise.
- PE is the exercise price of the option.
Also, the buyer must pay the premium option to issue, so the result you get is
the difference between net cash flow and premium:
Rc (t) = FNCC (t) - pc
being Rc (t) the result that the buyer gets the option on the date of exercise
and c p the premium option.
The buyer of a call option has a bullish profile losses and gains with stop loss.
As for the seller of a call option, he is obliged by charging
a premium to sell, at the request of the buyer, the underlying asset under the
conditions
specified in the option contract. The net cash flow that the seller gets is the
opposite of the buyer and is given by the following expression:
R( t) =FNC( t) + pc
Where:
R( t) is the result obtained by the seller of the option at the date of exercise
thereof.
The seller of a call option has a profile of bassist profit and loss limiting gains.
As regards the buyer of a put option acquires, by paying a premium, the right
to sell the underlying asset at the conditions specified in the option contract.
The net cash flow that gets the buyer depends on the value of the asset
underlying cash market on the date of exercise, being able to both following
situations:
The value of the underlying asset is less than the exercise price of the option,
which case the buyer has the right to sell the underlying asset price
established in the option, will benefit from the exercise of the same and will
run, obtaining a net cash flow equal to the difference between the price of
exercise of the option and the underlying asset price.
The underlying asset value is equal to or greater than the exercise price of the
option, in which case the buyer has the right but not the obligation to will sell
the underlying at the price established in the option asset will be impaired by
the exercise thereof and not run, obtaining a net cash flow equal zero.
A comparison on the buyer and seller is as follow:
4.1.2.4.4 Swaps
A swap contract is a derivative financial asset that is issued and not traded in
organized financial markets, in which two parties enter into an agreement to
exchange one set of net cash flows in the future, establishing at the time of
conclusion of the contract dates which will take place the exchange of such net
cash flows and the method used to determine the amount thereof.
These contracts can be considered as a succession in time contracts term, as a
forward contract produces a unique cash flow due in one only future time, while
a swap agreement produces one or more cash flows due in one or more future
time.
The swaps may have as a type of underlying asset exchange, interest rate or
credit risk associated with other financial asset. All derivative financial assets
that have been discussed above are part of the trading of financial institutions,
which the value using market value.
4.2 Debtors
The nature of the debtor is of great importance in measuring credit risk
because it depends on the fundamentals of risk measurement credit.
This nature influences the definition of the random variable "state in which is
the debtor "in the methods and models, whether empirical or theoretical, that
may be used in determining probability distribution in the explanatory variables
that can be used in these models and in the sample or population that can be
used in the determination of its parameters.
Furthermore, the nature of the debtor also influences the random variable "loss
event of default ", since it depends on the ability of the financial institution
require the debtor to fulfill its obligations in the event of default, this
safeguarding their interests.
In this sense, the lender can go to court in order to ask a bankruptcy where the
debtor is a private company or family, which does not occur when it is a public
entity.
One of the most important criteria is the size, in terms of which distinguishes
between large, medium and small businesses. However, in many cases the
classifications are obtained using the classification criteria are imprecise, which
is mainly due to the use of different variables and units.
As in the definition of the criteria results in that they are heterogeneous, on
especially when companies market goods and services in several countries and
are classified according to the criteria usually used in them.
default.
Each financial institution will have sufficient understanding of the
system
internal rating and capacity monitoring.
Commercial references from other suppliers with whom you have credit
Bank references
Conditions: These are the external factors that can affect the performance of
the business of the borrower, such as economic conditions and industry or the
political and economic situation in the region. Although these factors are not
9. Bibliographic references