Credit risk for 2013

[David Harper CFA FRM]

Hi FRMStrawberry, we gradually update the practice questions (i think some customers don't really understand how time-consuming new questions are; for example, it's taken me several hours today just to write three new questions for a tricky new AIM. New quality questions don't just magically appear, so it's not like anybody, can produce a full set of P2 2013 questions, for each and every new AIM, before the May Exam)

So ... yes, we keep the recent prior years' questions in the study planner (if they are in the Study Planner, then we consider them relevant) although we work hard to update it as fast as we can, thanks,

 

[Swarnendu Pathak]

Hi, David,
Can u please highlight about how to calculate Probability of Default (PD) in the IRB approach of Bassel II??

Swarnendu

 

[David Harper CFA FRM]

Hi Swarnendu,

PD is the one input factor that a bank can supply (i.e, use their internal method: it is not "calculated" within the IRB framework) under both FIRB and AIRB. Often they map from internal ratings. Maybe you mean, how to calculate (K) under IRB. If you search forum by "IRB" you'll find lots of discussion (if you have something more specific to ask, feel free to drill down):
http://forum.bionicturtle.com/search/3028287/?q=IRB&o=date

I have the IRB in an XLS here https://www.dropbox.com/s/2gq8gbsyjj8n4m4/7.c.3 basel_irb_v2.xls

(PD as yellow input; where IRB is the function that uses PD to return K)

Thanks,

 

[Swarnendu Pathak]

Thanks David for explanation.
Actualy i am thinking of various way for managing the credit risk in the bank's loan book portfolio, for which i am thinking for various process & steps & finally to capture the optimum amount of regulatory capital required to keep against the unexpected loan book loss without encurring extra cost for providing such capital other than optimum required. Can u please suggest some relevant readings on this?

Thanks

 

[David Harper CFA FRM]

Hi Swarnendu, I wish I had a single great regulatory capital reference, but I just don't ... I've learned most of my understanding from reviewing the papers at https://www.bis.org/
You might search the GARP digital library also, see http://www.garpdigitallibrary.org/
Good luck!

 

[Swarnendu Pathak]

Thanks
David for ur valuable suggestion.

 

[RiskNoob]

David Harper, CFA, FRM, CIPM
Suzanne Evans

Hi David, Suzanne,

Great! We already have Hull's T6 PQs, but these new PQs from Malz will definitely accompany the new readings in T6.

Not directly related to this T6 posting, but seems like T7 PQs are created lately. Does this mean we won't see any new T6 PQs in near future (say until the upcoming May exam in two months)?

If so, I am wondering if we can have a compiled PDF version of the PQs from Malz?

Thank you!

RiskNoob

 

[David Harper CFA FRM]

Hi RiskNoob,

Yes, in terms of sequence, I had to decide whether to continue (next in new questions) with Malz/Gregory counterparty (T6) or address the lack of a global T7 topic review, and I thought the global T7 topic review might be more helpful to the May Exam. So, you are correct, I won't resume PQ for the rest of Malz/Gregory until after the May exam (but I definitely will resume, so they will look forward to supporting Nov exam)

Re the PQ PDF for Malz, yes, I see in our internal PM that Suzanne has it queued up (we are always confronting priorities), it won't be long before the Malz PDF PQ is published to the SP. Thanks for looking forward to it!

 

[RiskNoob]

Hi RiskNoob,

Yes, in terms of sequence, I had to decide whether to continue (next in new questions) with Malz/Gregory counterparty (T6) or address the lack of a global T7 topic review, and I thought the global T7 topic review might be more helpful to the May Exam. So, you are correct, I won't resume PQ for the rest of Malz/Gregory until after the May exam (but I definitely will resume, so they will look forward to supporting Nov exam)

Re the PQ PDF for Malz, yes, I see in our internal PM that Suzanne has it queued up (we are always confronting priorities), it won't be long before the Malz PDF PQ is published to the SP. Thanks for looking forward to it!

Yes, T7 is an another huge (and dynamic in terms of content) topic which desires a PQ treatment compare to T5 and T6 which we already have a solid PD database. It is great to hear news about Global T7 topic review!

I have not read Gregory Chapters yet but I think PQs from Canabarro would handle Counterparty risk topic for now (based on your observation mentioned earlier in this thread). I think this is a good decision.

Thanks,

RiskNoob

 

[RiskNoob]

I meant PQ database... not PD. I think I already spent too much time reading huge contents in T6

 

[David Harper CFA FRM]

Hi RiskNoob, thank you, I really appreciate your agreement: I don't think most realize how time-consuming it is to write new questions (if there is a quality hurdle where in some cases many details must be cross-referenced). I spend most of my time writing questions; e.g., I got stuck Sunday for several hours just one one set. I personally will have more fun writing the new Gregory Counterparty questions, but it sounds like you agree, but I felt rather that a global T7 is more exam-practical for May. I do alternate P1/P2, which is another decision, but i think it's currently a good one ... (although we are approaching full density on P1, before the end of the year, I will be able to switch to P2/P2 sequence). Thanks for your comment, very helpful,

 

[RiskNoob]

Again, I really appreciate your dedication for providing quality material for BT customers, and understand the all new materials for 2013 might not be 100% delivered in May due to the high-turnover this year.

On the other hand, I also appreciate GARP's decision to provide some up-to-date materials (e.g. Malz and Gregory Chapters) to keep up the trend - I am really enjoying reading new chapters from Malz, Fascinating. personally my favourite readings in Credit Risk so far. (Except I wish I have more time to study to understand deeply due to the late book arrival, well, this is just me.)

But this leads to a predatory offering to both BT (and other third-party FRM study providers) and FRM candidates (i.e. referring to the initial discussion of this thread) - GARP just needs to have a bigger picture and handle these things well, probably like other well-known institutes such as CFAI.

RiskNoob

 

[privatepilot]

Hi David, I am quite new to BT but find it quite informative already.

I have a question on Credit Risk (apologies if I posting this at the wrong place... as I have yet to figure out the various forums and topics open).
pg 183 of P2.T6 2013 Credit Risk notes has this PQ

39.7.4. The credit risk-free mid-market value of a OTC derivatives portfolio is -$12.0 million to Bank A, and therefore +$12.0 million to the Counterparty B. The present-valued expected exposures, EE(A) and EE(B), and loss rates, s(A) and s(B), are the following: EE(A) = $40 million, s(A) = 1.0%; EE(B) = $50 million, s(B) = 2.0%. Each of the following is necessarily true EXCEPT:
a) The CVA adjustment, from Bank A's perspective, is -$600,000
b) Inclusive of CVA adjustment, the value of the position is -$12.6 million to Bank A
c) The funding benefit to Bank A is $600,000
d) The value (price) of credit risk faced by Counterparty B is $400,000

Given credit risk faced by B is +12.0 + CVA Adj of 0.6 m = 12.6
[CVA Adj for B = 50 X 2% - 40X1% = 0.6MM]

hence, I thought d) was clearly untrue. However, the answer focusses on c) on the premise it may not be true under some conditions.
What am I missing by thinking that correct answer should have been d) and not c).

will wait to hear from you. thanks a lot

 

[David Harper CFA FRM]

Hi privatepilot,

EE(A) refers to the exposure faced by B with respect to A and s(A) is Canabarro's notation for expected loss; s(a) = EL(A) = PD(A) * LGD(A), a default loss of A which is a credit risk to B. So, if we think about (A) defaulting, that is a risk (exposure) to A's counterparty who is B. I regret GARP discontinued Canabarro, if only b/c he represents a notational link between other credit risk and counterparty.

So, just from B's perspective, B has an expected loss = PD * LGD = 1.0% of a $40 million expected exposure = $400,000. If we ignore A's credit risk, this $400,000 could be dubbed a "unilateral CVA;" i.e,. price of credit risk. This is the interrelationship between market and credit risk, right here: if the portfolios are (eg) interest rate swaps, then changes in interest rate (market risk) can change the current value and the expected exposure, but the counterparty credit risk component is the expected loss due to default. And as the market risk is favorable, leading to increases in exposure (which are gains, not losses!), this increases the "price of credit risk" component by increasing the expected exposure. I hope that explains,

 

[privatepilot]

Thanks David. I do see your perspective. (Notwithstanding, I do feel that this question was a pretty tricky one)
Anyway, I really appreciate you taking the time to respond so promptly. You sure seem to be some kind of a super human, to keep a tab at so many forums and reply to each one of them ...! Wow...really hats off to you.

 

[Johnson]

Hi David,
This is my first post on the forum but you have been part of my life so far (seriously) in helping me out in clearing FRM part 1.I had just used your videos and frankly didn' get time to study much apart from that but cleared it.Now for part 2 , I had taken the BT material for Dec 2012 exam but had to postpone the exam. I again went through the videos for Market and operational risk for which syllabus is not changed.But am having nightmare going through the credit and current issues subjects.As its mentioned, there are new topics introduced from Malz for counterpary, spread risk & default intensity models, portfolio risk,structured credit risk and also Gregory with a lot of chapters on counter-party credit risk.
So I wanted to know can I use videos of you of last year which had syllabus mainly from Canabarro and others.I think the time is short to go for new books and am comfortable understanding it once I go through your videos.It would be great if you can tell how I should go about with these new topics added (like can I use Canabarro video on counterparty for this year Gregory chapters) and its relevance to the exam as you always mention in the videos.
Thanks.

 

[David Harper CFA FRM]

Hi goal2103,

Thanks for the kind words! First, I will have some new Credit videos (of course I won't be able to cover all of the new Credit before May ... by November, I will). I plan to hit the highlights in new videos. With respect to Canabarro, YES, he is relevant for CVA (in fact, his approach, in my opinion, is more testable for CVA than Gregory ... only because he gives relatively simple numerical examples .... while much of the Gregory will take significant time to manifest in a test question pattern of any reliable manner).

Second, with respect to May, I suggest do not over-rotate: GARP has dropped in massive new changes, 80%+ of Malz/Gregory will (frankly) never make the May test. That number is probably too low, by sheer arithmetic (For example, I don't think Canabarro even really made the exam in 2012 and his CVA is more accesssible, it takes time for new concepts to "season" a bit). Here is my hot tip: start with "calculate" AIMs, calculate AIMs suggest something concrete and more testable. After that, I would emphasize "shallow comprehension" rather than "deep dive" on individual AIMs, you will likely only need the key top-level ideas for May. Most of these AIMs have zero chance of being tested in May. I'm referring here to Credit. Current Issues (T9) is a different sort of animal, thanks,

 

[RiskNoob]

goal2013,

As for the current issue, the readings are quite interesting (at least for me) and not that difficult compare to other topics in FRM - 1 week would be enough to read all of the readings.

There will be around 8 questions (10%) from the current issue in the exam, so it would be better to review them once more before the exam in my opinion...

RiskNoob

 

[Johnson]

Thanks David,
That means there is a need not to emphasize and spend too much time on the topics in Malz and Gregory.So what I understand is that topics in these should be done with a broader picture in mind and not getting in depth on those while other topics in credit risk of Servigny, Stulz, Culp should be done in depth as their weight-age is high in the exam.
RiskNoob,
thanks.Its a relief to know that it would take about a week as time is short.

 

[GP_2012]

David,
Thank you for the advice in your response to goal2013. A follow-up question: when you say some of the new material may not make the test in May, from your experience, is there any chance that questions could be drawn from old readings that have been retired, just because they are seasoned?