ULC

[MagnusNordzell]

Hi,

I have seen quite a few references and formulas related to ULC and UL quantification in the Part 1 course material (e.g. questions 4, 8 and 12 on the mock exam). However, I cannot seem to find any material covering this topic in the GARP books. Is this topic in scope in the Part I curriculum? My feeling is that it has been moved to the Part II curriculum.

Thanks,
Magnus

 

[David Harper CFA FRM]

Hi @MagnusNordzell UL and ULC (aka, risk contribution) have always been included in P1.T4. See below, comparison of 2019 LOs to 2020 LOs (emphasis mine). Let's be real about what's going on: GARP just switched the author and the new author presents a slightly different approach to retrieve ULC/RC but the result is the same, and frankly, Schroeck's method is better, more testable and has the advantage of consistency with P2.T6 presentation of ULC/RC. It is true that P1.T4 is focused on the calculation of UL and UL and only "introduces" the calculation (determination) of UL contribution while UL contribution is a specific focus of P2.T6., so in the future I may dial-back the RC in the P1 mock but to be brutally candid, I know better than to assume GARP has a detailed intention here. These author switches wreak much more confusion than this instance here, and they are 95% unintentional (i.e., they are not due to some careful design but rather driven by convenience at the expense of candidates and EPPs. In many cases, two author changes gets us right back to the original spot!). All that happened is the author switched (and he calculates the same RC in a different way), the testable set remains the same, and Schroeck's ULC is more versatile. I hope that's helpful,

2019 LOs:

Gerhard Schroeck, Risk Management and Value Creation in Financial Institutions (New York, NY: John Wiley & Sons, 2002).
Chapter 5. Capital Structure in Banks (pages 170-186 only) [VRM–14]
After completing this reading you should be able to:
• Evaluate a bank’s economic capital relative to its level of credit risk.
• Identify and describe important factors used to calculate economic capital for credit risk: probability of default,
exposure, and loss rate.
• Define and calculate expected loss (EL).
• Define and calculate unexpected loss (UL).
• Estimate the variance of default probability assuming a binomial distribution.
• Calculate UL for a portfolio and the UL contribution of each asset.
• Describe how economic capital is derived.
• Explain how the credit loss distribution is modeled.
• Describe challenges to quantifying credit risk.

2020 LOs:

Chapter 6. Credit Risk and Capital Modeling [VRM–6]
After completing this reading you should be able to:
• Evaluate a bank’s economic capital relative to its level of credit risk.
• Explain the distinctions between economic capital and regulatory capital and describe how economic
capital is derived. Identify and describe important factors used to calculate economic capital for credit
risk: probability of default, exposure and loss rate.
• Define and calculate expected loss (EL).
• Define and explain unexpected loss (UL).
• Estimate the mean and standard deviation of credit losses assuming a binomial distribution.
• Describe the Gaussian copula model and its application.
• Describe and apply the Vasicek model to estimate default rate and credit risk capital for a bank.
• Describe the CreditMetrics model and explain how it is applied in estimating economic capital.
• Describe and use the Euler’s theorem to determine the contribution of a loan to the overall risk of a portfolio.
• Explain why it is more difficult to calculate credit risk capital for derivatives than for loans.
• Describe challenges to quantifying credit risk