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Structuring and Pricing Complex Credit Assets with Monte Carlo / @RISK. 22.06.2006 – Jörg Günther. EQUITY VS. CREDIT ASSETS. Balance Sheet Assets Current Assests - - - Fixed Assets - -. Cash Flows CF from Operations CF from Investing

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Structuring and pricing complex credit assets with monte carlo @risk

Structuring and Pricing Complex Credit Assets with Monte Carlo / @RISK

22.06.2006 – Jörg Günther


EQUITY VS. CREDIT ASSETS Carlo / @RISK

  • Balance Sheet

  • Assets

  • CurrentAssests---

  • Fixed Assets--

  • Cash Flows

  • CF from Operations

  • CF from Investing

  • CF from Financing(or: what is left for 1. Debt Service 2. Equity Distributions)

  • E&L

  • Equity--

  • Debt--

Pricing-

models

  • Asset Markets Equity Stock-Price Debt Debt-Price; CDS


EQUITY VS. CREDIT ASSETS - DERIVATIVES Carlo / @RISK

  • Equity Derivatives

  • Vanilla Options(Call/Put)

  • Complex Options(Barrier, Basket, Cliquet, ...)

  • Credit Derivatives

  • Credit Default Swaps(Credit Risk)

  • CDO-Tranches

  • other...

  • Equity and Credit Assets – and their Derivatives - are

  • structurally different, but are ultimately based on the

  • same original Cash Flow of an Entity


DIFFERENCES OF EQUITY AND CREDIT ASSETS Carlo / @RISK

  • Equity Assets

  • liquid markets

  • abundant empirical data on

    • Underlyings

    • Options

  • Credit Assets

  • Illiquid markets

  • less empirical data, different focus (default/non-default)

  • Sophisticated Market & Models

  • Market & Models„work in progress“


S&Ps RATING METHODOLOGY FOR CDO-TRANCHES Carlo / @RISK

  • Loss Distribution

  • Monte-Carlo for Synthetic CDO- Structure

    • PDs

    • Recovery Rates

    • Correlation

  • Cash-Flow-CDO-Application

  • Scenarios for

    • Timing of default

    • Interest rates

  • Loss-Distribution used as input for cash-flow-model


BASEL II – HOW MONTE CARLO HELPS TO COVER REGULATORY ISSUES

  • Balance Sheet Bank

  • Assets

  • Loans

  • E&L

  • Equity

  • Debt

  • Basel II

  • in % of loan

  • risk-adjusted

  • Standard

  • non-specific,i.e. same orstandardizedrisk-weight;on averagemore equiyto be provided

  • IRB

  • eg Project Finance:

  • Based on Monte-Carlo

  • More specificRating;on averageless equity


PRICING A WIND POWER PROJECT-FINANCE-DEAL ISSUES

  • Cash Flow Model

  • assumptions

  • Sources / Uses

  • Operating Cash Flow

  • Financing Cash Flow

  • Risk-Parameters

  • Scenarios (what-if)

  • Stochastic Assumptions

  • Monte-Carlo

  • Expected Loss

  • Rating-Class

Spread-sheet-example:

Wind-Power-Project


STRUCTURING A PORTFOLIO LOAN – THE CASH FLOW STRUCTURE ISSUES

  • Cash Flow of Underlyings

  • Timing Assumptions

  • Stochastic Assumptions

    • Asset return

    • Volatility

    • Correlation

  • Cash Flow of Financing Structure

  • Order of financing and repayment/distributions

  • defining loss / recovery rate

Spread-sheet-example:

PE-blind-pool


STRUCTURING A PORTFOLIO LOAN – APPLYING MONTE-CARLO FOR THE PRICING

  • Structuring Parameters

  • Size of Equity-Tranche

  • Order of Distributions (Cash-Flow-Waterfall)

  • Interests

  • Outputs of Analysis

  • Expected Loss

  • Return on Bank‘s Equity

  • Return on Sponor‘s Equity

  • Volatility / Risk of Returns

    • Precise Pricing

    • Precise Risk-Return-Packaging

Spread-sheet-example:

PE-blind-pool


FUNCTIONS OF @RISK OFTEN USED THE PRICING

  • Function

  • Distributions

  • Correlation Matrix

  • Fit to Distribution

  • D-Uniform-Distribution

  • Issue / Questions involved

  • Calculating Risk: Static -> StochasticAnalysis (Scenario -> Monte-Carlo)

  • Quantifying Diversification:Portfolio-Structures

  • Analyzing empirical data

  • Bootstrapping


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