Part III Investment Banking, 16 Credit Value Adjustment

2018 ◽  
Author(s):  
Gleeson Simon
Keyword(s):  
Credit Risk ◽  
Investment Banking ◽  
Fair Value ◽  
Credit Spread ◽  
Number Of Factors ◽  
Derivative Instruments ◽  
Counterparty Credit Risk ◽  
Capital Charge ◽  
Good Proxy ◽  
Basel 3

The chapter discusses credit value adjustment (CVA) under Basel 2.5 and Basel 3. CVA is an adjustment to the fair value (or price) of derivative instruments to account for counterparty credit risk (CCR). Thus, CVA is commonly viewed as the price of CCR. The purpose of the CVA capital charge is to capitalize the risk of future changes in CVA. For most exposures, at any given time the market credit spread on the relevant counterparty is good proxy for the CVA applicable to the exposure, but the regulatory calculations involved reflect a number of factors as well as this particular input.

Part III Investment Banking, 12 The Trading Book

2018 ◽  
Author(s):  
Gleeson Simon
Keyword(s):  
Credit Risk ◽  
Investment Banking ◽  
Market Risk ◽  
Market Risks ◽  
Counterparty Credit Risk ◽  
Basel 3

This chapter begins by discussing market risk in the Basel framework. Market risk was a relative latecomer to the Basel framework. Although the original Accord was signed in 1988, it was only in 1996 that the amendment to incorporate market risks was implemented. Market risk in the trading book is comprised of two significant components: position risk, which measures the risk of a change in the value of assets held; and counterparty credit risk, which measures the riskiness of counterparties to derivatives, options, and other trading positions. The remainder of the chapter covers trading book eligibility under Basel 2.5 and Basel 3.

Part III Investment Banking, 18 Securitization and Repackaging

2018 ◽  
Author(s):  
Gleeson Simon
Keyword(s):  
Credit Risk ◽  
Investment Banking ◽  
Basel Accord ◽  
Separate Treatment ◽  
Revolving Credit ◽  
Basel 3

This chapter discusses securitization requirements under Basel 3. The Basel 3 reforms have rewritten the capital treatment of securitisations. However this rewriting sits on top of some major restructuring of the regime effected by Basel 2.5. Given that the Basel Accord is intended to reflect credit risk, it might be expected that the rationale for a separate treatment of securitization exposures would have disappeared, and that exposures to securitization vehicles would be evaluated in exactly the same way as exposures to other types of vehicles, based on credit characteristics. However, the opposite is the case. The chapter begins with an explanation of securitization. It then discusses true sale and derecognition of assets, risk weighting of securitization exposures, weighting holdings of securitization positions, the internal ratings-based approach approach, and revolving credit securitizations.

Part III Investment Banking, 17 Derivatives, Clearing, and Exposures to CCPs

2018 ◽  
Author(s):  
Gleeson Simon
Keyword(s):  
Credit Risk ◽  
Internal Model ◽  
Investment Banking ◽  
Policy Responses ◽  
Model Method ◽  
Exposure Method ◽  
Standardized Method ◽  
Basel 3 ◽  
Current Exposure

This chapter discusses requirements for derivatives, clearing and exposures to CCPs. In September 2009, as one of the primary policy responses to the crisis, G20 leaders at the Pittsburgh summit decided to promote central clearing of derivatives, and legislation is now in place to provide a framework for compelling banks to do this. However, clearing increases the risk exposures of banks providing that clearing service, since the bank retains the risks arising from the original derivative transaction, and adds to them any risks arising from the clearing process. In general, a bank will measure its derivative exposures using one of three methods: the Internal Model Method; the Standardized Method; or the Current Exposure Method. The risk weight is that which applies to the counterparty under the Standardized Approach (SA) or internal ratings-based approach for credit risk. However, these approaches will be replaced by the SA-CCR under Basel 3.

Part III Investment Banking, 15 Counterparty Risk in the Trading Book

2018 ◽  
Author(s):  
Gleeson Simon
Keyword(s):  
Credit Risk ◽  
Market Value ◽  
Investment Banking ◽  
Future Price ◽  
Counterparty Risk ◽  
The Future ◽  
Counterparty Credit Risk ◽  
Degree Of Risk ◽  
Rules Set ◽  
Level Of Risk

This chapter sets out rules that result in certain exposures being treated as having a greater degree of risk than their actual mark to market value. In order to explain this, consider a bank which owns 100 of shares in A, but also has a derivative in place with X under which it is entitled to be paid the value of 100 shares in A. Both positions give rise to the same risk as to the future price of A, and both will be valued by reference to the value of the shares in A. However, if the value of the shares in A increases, the bank's credit exposure to X will increase. The rules set out in this chapter seek to capture this extra level of risk by treating the value of the derivative as being slightly higher than its mark to market value; thereby requiring a slightly higher level of capital to be held against it. This is the counterparty credit risk requirement (CCR).

Cost of capital and asset characteristic value

2021 ◽  
pp. 2150007
Author(s):  
Bill Y. Shen
Keyword(s):  
Stock Price ◽  
Cost Of Capital ◽  
Investment Decision ◽  
Fair Value ◽  
Secondary Market ◽  
Credit Spread ◽  
Structure Model ◽  
Characteristic Value ◽  
Option Theory ◽  
The Cost

We propose a possible alternative to WACC as cost of capital for a business investment decision through option theory. The cost of capital in this new definition becomes forward-looking and easy to compute with traded market information as inputs. More importantly, it is a fair value- based approach and does not depend on investors’ own expectation. An important parameter “asset characteristic value” is identified and its role is further illustrated by using Merton’s capital structure model. Asset characteristic value can be calibrated by using stock price or credit spread observed from a secondary market.

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