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Unified Financial Analysis Risk & Finance Lab

Unified Financial Analysis Risk & Finance Lab. Chapter 13: The going-concern view / General mechanisms Willi Brammertz / Ioannis Akkizidis. Taxonomy of Analysis. Markets. Markets. Natural Time. Behavior. Counter- parties. Behavior. Counter- parties. Contracts. Contracts.

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Unified Financial Analysis Risk & Finance Lab

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  1. Unified Financial Analysis Risk & Finance Lab Chapter 13: The going-concern view / General mechanisms Willi Brammertz / Ioannis Akkizidis

  2. Taxonomy of Analysis

  3. Markets Markets Natural Time Behavior Counter-parties Behavior Counter-parties Contracts Contracts Dynamic Simulation e1 e2 e3 en Financialevents … Investment Horizon Liquidity Value Income Sensitivity L@R E@R V@R Risk

  4. NPV Static Analysis Assets Existing Business Time Existing Business Liabilities t0 Volatility in t0 () Yield Time to Maturity

  5. Dynamic Analysis • New volume /reinvestment • Type of new business • Pricing Assets New Business Existing Business Time Liabilities Existing Business t0 New Business Spread Yield curve t2 Yield curve t1 Yield curve t0 ... Yield Time to Maturity P&L

  6. Static analysis vs. going concern • Reasons why going concern is important • Life is a flow (and so is finance) • Relative obscurity of the going concern view • Increasing importance

  7. Elements of dynamic simulation • Market forecast • New production (of financial contracts) • Other risk factors (Counterparties, Behavior) • Cost (and other revenues, P&L)

  8. Market Forecast • Forward rates • <> Economic forecast • Biased • Economic forecast, real world (see chapter 4) • Techniques • What-If • Monte Carlo

  9. New productionVolume

  10. Conflicting volume targets • Different strategy elements affect volumes • Reinvestment • Behavioral • Target volumes • Order of execution • Needs conflict resolution • Target volume is last • „Not in addition“ • „In addition“

  11. New productionContract characteristics • Main characterisitcs (no unnecessary detail!) • Contract type • Tenor • Repricing • Cycles (depending on CT) • Few others... (depending on CT)

  12. New productionAdding new contracts

  13. New productionTurning volume into contracts

  14. New productionPricing • Par rate in case of non-PAM‘s!

  15. New productionPricing under credit risk

  16. Behavior and counterparty • Behavior • Normaly kept constant during dynamic simulation runs • Exception: stress testing • Stochastic behavior: possible option for future • Counterparty • Unrealistic to simulate single counterparties • Exception: very large exposures • Simulation on the level of rating groups

  17. Cost and „other revenues“ • Cost in static analysis normally neglected (if Δt=0, cost does not really exist) • To neglect cost in dynamic analysis means enjoying a fantastic profitability (but only on paper) • This can be easily seen in the dynamic balancing equation

  18. Financial analysis and book keeping • Where are the book keepers statements? • Where is the chart of accounts • Closely related to the concept of balancing • Distinguish between • Static analysis • Dynamic Analysis

  19. BalancingStatic • The static balancing equation • How is an inequality possible in t0?

  20. Dynamic balancingOn book-keepers terms only • Example: • Asset is simple coupon bearing bond 10% • Liability is simple (linear) zero-coupon bond 10% • Contradiction: P&L is 0 but equity shrinks: dynamic balancing equation is violated

  21. Dynamic balancingOn treasurers terms (then book keeping) • Conclusion: Banks balance in reality on cash flow basis • Books balance only after balancing on cash flow basis

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