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Structuring and Pricing Complex Credit Assets with Monte Carlo / @RISKPowerPoint Presentation

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

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### 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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