Optimizing return on regulatory and economic capital is a key concern for bank portfolio managers. Reducing the capital backing existing holdings can help redeploy the capital to more profitable businesses, shrink the balance sheet, or boost returns.
One obvious way of reducing the capital held is to sell a particular set of assets that are capital-intensive. But these assets tend also to be the ones that yield more and selling them could harm the return on the banks portfolios. CDO technology enables banks to keep most of the returns while significantly reducing regulatory capital.
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Posted in Finance, Strategy
In recent years, the market for collateral debt obligations (CDOs) and, in particular, the development of the synthetic CDO market and correlation trading has resulted in significant developments in valuation and risk management for such products. The market has been dominated by developments around the static Gaussian copula model, the introduction of base correlation as an alternative to the compound correlation, and extensions to better capture the observed correlation smile/skew, only recently more dynamic models that incorporate credit spreads or other major modeling parameters have been introduced by practitioners and academics.
All valuation approaches are based on risk-neutral pricing principles and little focus has been given to replication-based arguments that would also lead to developments for practical hedging and risk management. Currently, risk management often focuses on static risk measures that address the likelihood of a CDO investor receiving full notional and actual interest in a timely manner (ratings perspective), or on mark-to-market (MtM) sensitivities and “the greeks” frequently employed by correlation investors and traders.
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Posted in Finance, Investment, Loan
Acredit rating represents the agency’s opinion about the creditworthiness of an obligor, with respect to a particular debt security or other financial obligation (issue-specific credit ratings). It also applies to an issuer’s general creditworthiness (issuer credit ratings).
There are generally two types of assessment corresponding to different financial instruments: long-term and short-term ones. One should stress that ratings from various agencies do not convey the same information. S&P perceives its ratings primarily as an opinion on the likelihood of default of an issuer,* while Moody’s ratings tend to reflect the agency’s opinion on the expected loss (probability of default times loss severity) on a facility.
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Posted in Strategy