CH9 - Credit Portfolio Management

Question 1

Level 1 CPM

Answer 1

• Basic CPM consists of the minimum activities that need to be performed by any company exposed to credit risk
• The focus is on prudent risk taking via strict limits, on the knowledge of the composition of the portfolio and on the monitoring of its performance

Question 2

Level 1 CPM - Aggregation

Answer 2

-Measuring the accumulation of risk for each counterparty
E.g. We may have two exposures to the one company: a trade receivable and a derivative position. These two exposures must be aggregated, because if this company were to default, losses would be experienced on both exposures
-Ultimate parent needs to be identified along with each subsidiary and affiliate on a global basis

Question 3

Level 1 CPM - Reporting

Answer 3

Common for banks to prepare daily summary reports on exposures, as they can change quickly. It should present things such as:

• Largest absolute exposures
• Largest weak exposures
• Large new transactions etc

Question 4

Level 1 CPM - Credit Limits and Surveillance

Answer 4

Limits should be:
1. Applicable to counterparties, industries, countries etc
2. Set in advance and change infrequently
3. Enforced
4. Subject to judgment and review
5. Set for multiple exposure metrics (e.g. VaR)
Surveillance: refers to the monitoring of the performance of the transaction and counterparty after the deal has been closed

Question 5

Level 2 CPM (points 1 and 2)

Answer 5

• Intermediate CPM requires analytical skills and tools, because the focus here is on the amount of capital at risk and on profitability
  1. Quantification of Capital at Risk; cushion has to be built to prevent the firm against insolvency (capital, CVaR)
  2. Allocation of Capital and Profitability at individual transaction level: allocate the aggregate amount to individual transactions, helps with pricing

Question 6

Level 2 CPM (points 3 and 4)

Answer 6

3. Stress Testing: evaluating the economic consequences of unexpected but plausible events that may impact the performance of the counterpaties, and thus the entire portfolio
4. Hedging Strategy: hedging positions instead of dedicating resources

Question 7

Level 3 CPM

Answer 7

An active CPM strategy integrates portfolio management concepts in the day-to-day operations of a company
After deal execution, transactions become the assets of CPM, and in some instances CPM’s profitability is measures as any other business group: see transfer pricing

Question 8

Level 3 CPM: Transfer Pricing

Answer 8

• Intracompany transactions such as the allocation of expenses for shared services or charges associated with the purchase of a product or service
• In RM context, the key idea is to disposses business units of their exposure immediately after closing a transaction. The ownership is transferred to CPM group by selling the exposure via a funds-transfer price that the originator can recognise as income, which then shifts the performance burden onto the CPM group that has the responsibility to manager the portfolio it owns