Credit Risk and Exposure in Securitization and Transactions PDF
Preview Credit Risk and Exposure in Securitization and Transactions
CREDIT RISK AND EXPOSURE IN SECURITIZATION AND TRANSACTIONS Also by T. H. Donaldson HOW TO HANDLE PROBLEM LOANS LENDING IN INTERNATIONAL COMMERCIAL BANKING THE MEDIUM-TERM LOAN MARKET (with J. A. Donaldson) THINKING ABOUT CREDIT UNDERSTANDING CORPORATE CREDIT Credit Risk and Exposure in Securitization and Transactions T. H. Donaldson, F.e.LB. Palgrave Macmillan ISBN 978-1-349-10363-8 ISBN 978-1-349-10361-4 (eBook) DOI 10.1007/978-1-349-10361-4 © T. H. DonaIdson, F.C.I.B., 1989 Softcover reprint ofthe hardcover 1s t edition 1989 978-0-333-47050-3 All rights reserved. For information, write: Scholarly and Reference Division, St. Martin's Press, Inc., 175 Fifth Avenue, New York, N.Y. 10010 First published in the United States of America in 1989 ISBN 978-0-312-03094-0 Library of Congress Cataloging-in-Publication Data DonaIdson, T. H. (Thomas Hay), 1936- Credit risk and exposure in securitization and transactions. Includes index. 1. Bank loans. 2. Credit. 3. Risk management. I. Title. HG1641.D67 1989 332.1'753'0685 88-35566 ISBN 978-0-312-03094-0 Contents List of Glossary Items viii Acknowledgements x 1 INTRODUCTION 1 Glossary 1 Developments in substitutes and supplements for lending 2 The difference between borrower/counterparty risk and transaction risk 4 The need to identify and understand the different risks 6 The purpose and structure of the book 8 PART I RECOGNIZING RISK 2 THE DIFFERENT TYPES OF RISK 13 Glossary 13 Risk v. exposure 14 Proxies for exposure 15 Broad categories of risk 17 How risks interact 27 3 UNDERSTANDING THE RISK 29 Glossary 29 The strength of the borrower 29 Does the transaction change the credit of the borrower? 31 Does the transaction change the probable size of loss? 34 Have we identified the true risks of the transaction? 37 Risk transferred still exists 40 Change in form may reduce protection 42 PART II DETAILS OF RISK 4 CREDIT AND RELATED RISK 47 Glossary 47 The risk of a loan or direct credit (lending risk) 48 v VI Contents Settlement risk 51 Clearance risk 55 Documentation risk 60 Operating risk 69 Secured, senior or subordinated 71 Put not thy trust ... 79 5 TRADING AND RELATED RISK 81 Glossary 81 Trading risk 82 Market making risk 87 Underwriting risk 88 Investment risk 92 Hedging risk 93 The interaction with credit risk 95 Illiquidity risk 98 Mismatch risk 100 All swings, no roundabouts risk 102 Insider trading/conflict of interest risk 103 PART III RISK IN INSTRUMENTS 6 LOANS AND LOAN SUBSTITUTES 107 Glossary 107 Traditional loans 108 Deposits and redeposits 110 Bonds and FRNs 111 NIFs, RUFs, and MOFs 115 Zero coupon and deep discounted bonds 119 Synthetic assets 121 Loans bought and sold 122 7 TRADING INSTRUMENTS 130 Glossary 130 Forward and spot exchange 130 Interest rate swaps 134 Currency swaps 135 Options, warrants and futures 138 Forward rate agreements (FRAs) 141 Caps, floors and collars 142 Hybrids 143 Contents VB PART IV RISK/REWARD 8 CAPITAL ADEQUACY 147 Glossary 147 Introduction 147 Capital requirements for different risks 148 Loan equivalents 150 Return on capital, on assets and on risk 156 Prudential regulation-a blessing or a curse? 161 Only themselves to blame 164 Index 167 List of Glossary Items Figures refer to the chapters in which words or phrases are expained. Basle Committee 8 Borrower 1 Cap 7 Capital adequacy (ratio) 8 Cash flow 3 Clearance risk 4 Collar 7 Commercial bank 1 Contract risk 4 Contracts for differences 2 Cooke Committee 8 Counterparty 1 Credit risk 1 Currency swap 5 Daily settlement limit 4 Deep discount 6 Delivery v. payment (DVP) 4 (Dis)intermediation 1 Documentation risk 4 Due diligence 6 Exposure 2 Floating rate note (FRN) 5 Floor 7 Forward rate agreement 7 GlO 8 In the money 5 Interest rate swap 5 Investment bank 1 LIBID 2 LIBOR 2 LIMEAN 2 Loan equivalent 8 Mark to market 8 Market maker 6 Master agreement 4 Vlll List of Glossary Items IX Merchant bank 1 Multiple option facility (MOF) 6 Net working investment 3 Note issuance facility (NIF) 6 Off balance sheet 5 Operating risk 4 Revolving underwriting facility (RUF) 6 Risk 2 Securitization 1 Seniority 3 Settlement risk 2 Standby commitment 5 Subordinated debt 3 Trading risk 2 Underwriting risk 2 Upfront payment 1 Warrant 5 Yield curve 5 Zero coupon bond 6 Zero sum 3
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