Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ THE HANDBOOK OF STRUCTURED FINANCE ARNAUD DE SERVIGNY NORBERT JOBST McGraw-Hill New York Chicago San Francisco Lisbon London Madrid Mexico City Milan New Delhi San Juan Seoul Singapore Sydney Toronto Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ Copyright © 2007 by The McGraw-Hill Companies All rights reserved Manufactured in the United States of America Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher 0-07-150884-8 The material in this eBook also appears in the print version of this title: 0-07-146864-1 All trademarks are trademarks of their respective owners Rather than put a trademark symbol after every occurrence of a trademarked name, we use names in an editorial fashion only, and to the benefit of the trademark owner, with no intention of infringement of the trademark Where such designations appear in this book, they have been printed with initial caps McGraw-Hill eBooks are available at special quantity discounts to use as premiums and sales promotions, or for use in corporate training programs For more information, please contact George Hoare, Special Sales, at george_hoare@mcgraw-hill.com or (212) 904-4069 TERMS OF USE This is a copyrighted work and The McGraw-Hill Companies, Inc (“McGraw-Hill”) and its licensors reserve all rights in and to the work Use of this work is subject to these terms Except as permitted under the Copyright Act of 1976 and the right to store and retrieve one copy of the work, you may not decompile, disassemble, reverse engineer, reproduce, modify, create derivative works based upon, transmit, distribute, disseminate, sell, publish or sublicense the work or any part of it without McGraw-Hill’s prior consent You may use the work for your own noncommercial and personal use; any other use of the work is strictly prohibited Your right to use the work may be terminated if you fail to comply with these terms THE WORK IS PROVIDED “AS IS.” McGRAW-HILL AND ITS LICENSORS MAKE NO GUARANTEES OR WARRANTIES AS TO THE ACCURACY, ADEQUACY OR COMPLETENESS OF OR RESULTS TO BE OBTAINED FROM USING THE WORK, INCLUDING ANY INFORMATION THAT CAN BE ACCESSED THROUGH THE WORK VIA HYPERLINK OR OTHERWISE, AND EXPRESSLY DISCLAIM ANY WARRANTY, EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE McGraw-Hill and its licensors not warrant or guarantee that the functions contained in the work will meet your requirements or that its operation will be uninterrupted or error free Neither McGraw-Hill nor its licensors shall be liable to you or anyone else for any inaccuracy, error or omission, regardless of cause, in the work or for any damages resulting therefrom McGraw-Hill has no responsibility for the content of any information accessed through the work Under no circumstances shall McGraw-Hill and/or its licensors be liable for any indirect, incidental, special, punitive, consequential or similar damages that result from the use of or inability to use the work, even if any of them has been advised of the possibility of such damages This limitation of liability shall apply to any claim or cause whatsoever whether such claim or cause arises in contract, tort or otherwise DOI: 10.1036/0071468641 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ Professional Want to learn more? 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If you’d like more information about this book, its author, or related books and websites, please click here Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ For more information about this title, click here CONTENTS INTRODUCTION v Chapter Overview of the Structured Credit Markets by Alexander Batchvarov Chapter Univariate Risk Assessment by Arnaud de Servigny and Sven Sandow 29 Chapter Univariate Credit Risk Pricing by Arnaud de Servigny and Philippe Henrotte 91 Chapter Modeling Credit Dependency by Arnaud de Servigny 137 Chapter Rating Migration and Assset Correlation by Astrid Van Landschoot and Norbert Jobst 217 Chapter CDO Pricing by Arnaud de Servigny 239 Chapter An Introduction to the CDO Risk Management by Norbert Jobst 295 Chapter A Practical Guide to CDO Trading Risk Management by Andrea Petrelli, Jun Zhang, Norbert Jobst, and Vivek Kapoor 339 Chapter Cash and Synthetic CDOs by Olivier Renault 373 iii Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ CONTENTS iv Chapter 10 The CDO Methodologies Developed by Standard and Poor’s 397 Chapter 11 Recent and Not So Recent Developments in Synthetic CDOs by Norbert Jobst 465 Chapter 12 Residential Mortgage-Backed Securities by Varqa Khadem and Francis Parisi 543 Chapter 13 Covered Bonds by Arnaud de Servigny and Aymeric Chauve 593 Chapter 14 An Overview of Structured Investment Vehicles and Other Special Purpose Companies by Cristina Polizu 621 Chapter 15 Securitizations in Basel II by William Perraudin 675 Chapter 16 Secritization in the Context of Basel II by Arnaud de Servigny 697 BIOGRAPHIES INDEX 765 759 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ INTRODUCTION T he Handbook of Structured Finance presents many modern quantitative techniques used by investment banks, investors, and rating agencies active in the structured finance markets In recent years, we have observed an exponential growth in market activity, knowledge, and quantitative techniques developed in industry and academia, such that the writing of a comprehensive book is becoming increasingly difficult Rather than trying to cover all topics on our own, we have taken advantage from the expert wisdom of market participants and academic scholars and tried to provide a solid coverage of a wide range of structured finance topics, but choices had to be made The clear objective of this book is to blend three types of experiences in a single text We always aim to consider the topics from an academic standpoint, as well as from a professional angle, while not forgetting the perspective of a rating agency The review in this book goes beyond a simple list of tools and methods In particular, the various contributors try to provide a robust framework regarding the monitoring of structured finance risk and pricing In order to so, we analyze the most widely used methodologies in the structured finance community and point out their relative strengths and weaknesses whenever appropriate The contributors also offer insight from their experience of practical implementation of these techniques within the relevant financial institutions Another feature of this book is that it surveys significant amounts of empirical research Chapters dealing with correlation, for example, are illustrated with recent statistics that allow the reader to have a better grasp of the topic and to understand the practical implementation challenges Although the book focuses on collateral debt obligations (CDOs), it provides extensive insight related to other vehicles and techniques employed for residential mortgage-backed securities, Credit card securitization, Covered Bonds, and structured investment vehicles v Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ Copyright © 2007 by The McGraw-Hill Companies Click here for terms of use vi INTRODUCTION STRUCTURE OF THE BOOK The book is divided into 16 chapters We start with the building blocks that are necessary to price and measure risk on portfolio structures This involves pricing techniques for single-name credit instruments (univariate pricing), and estimation/modeling techniques for default probabilities and loss given default (univariate risk) of such products We then focus on dependence, and more specifically on correlation in general terms, applied to correlation among corporates as well as across structured tranches Once this toolbox is available, we can move to the CDO space, the second part of this book We investigate the techniques related to CDO pricing, CDO strategy, CDO hedging, the CDO risk assessment employed by Standard & Poor’s, and we end up with an overview of recent developments in the CDO space A third building block is based on a review of the methods used in the RMBS sector, for Covered Bonds, for Operating Companies, and finally we focus on Basel II both from a theoretical as well as from a case study perspective ACKNOWLEDGMENTS As editors, we would like to thank all the contributors to this book: Alexander Batchvarov, Sven Sandow, Philippe Henrotte, Astrid Van Landschoot, Olivier Renault, Vivek Kapoor, Varqa Khadem, Francis Parisi, Cristina Polizu, Aymeric Chauve, and William Perraudin Our gratitude also goes to those who have helped us in carefully reading this book and providing valuable comments We would like to thank in particular Jean-David Fermanian, Pieter Klaassen, Andre Lucas, Jean-Paul Laurent, Joao Garcia, Olivier Renault, Benoit Metayer, and Sriram Rajan Arnaud de Servigny Norbert Jobst Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ CHAPTER Overview of the Structured Credit Markets: Trends and New Developments Alexander Batchvarov OVERVIEW OF STRUCTURED FINANCE MARKETS AND TRENDS The easiest way to highlight the development of the structured finance market is to quantify its new issuance volume That volume has been steadily climbing all over the world, with U.S leading, followed closely by Europe, and Japan and Australia a distant third and fourth The rest of the world is now awakening to the opportunities offered by structured credit products to both issuers and investors and gearing up for a strong future growth In that respect, it is worth mentioning Mexico, which is leading the way in Latin America; South Korea and Republic of China lead in continental Asia and Turkey in for the Middle East and Eastern Europe It is only a matter of time before Central and Eastern Europe and China and India spring into action, and the Middle East launches its own version of securitization The data shown in Tables 1.1 to 1.4 are based on publicly available information about deals executed on each market We believe such data to seriously understate the size of the respective markets due to several factors: ♦ the availability of private placement markets in many countries, data for which are not widely available; ♦ the execution of numerous transactions executed for a specific client, known as bespoke or custom-tailored deals, especially in Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ Copyright © 2007 by The McGraw-Hill Companies Click here for terms of use CHAPTER ♦ the area of synthetic collateralized debt obligations (CDOs) and synthetic risk transfers; the exclusion from the count of many transactions based on synthetic indices, such as iTraxx and CDX, ABX, etc., whereby structured products are created using tranches from those indices That being said, the publicly visible size of the markets and their growth rates are sufficient to attract investors, issuers, and regulators The structured finance market growth also stands out against the background of declining bond issuance volumes by corporates and the rising issuance volumes of covered bonds, which in turn are increasingly becoming more “structured” in nature The markets of United States, Australia, and Europe can be viewed as international markets, i.e., providing supply to both domestic and foreign investors on a regular basis and in significant amounts, whereas the other securitization markets remain predominantly domestic in their focus The international or domestic nature of a given market is not only related to where the securities are sold and who the investors are, but also to the level of disclosure, availability of information and, subsequently, the level of quantification (as opposed to qualification) of the risks involved, in particular structured finance securities and underlying pools If we were to rank the markets by the level of disclosure of information about the structured finance securities and their related asset pools, we should consider the U.S market as the leader by far in terms of breadth, depth, and quality of the information provided—being the oldest structured finance market helps, but it is not the only reason: investor sophistication, type of instruments used (those subject to high convexity risk, for example), bigger share of lower credit quality securitization pools, higher trading intensity with related desire to find and explore pricing inefficiencies, etc are all contributing factors Other structured finance markets, however, are making strides in that direction as well Some of the reasons are associated with the type of instruments used: say, convexity-heavy-Japanese mortgages, refinancing-driven UK subprime, default- and correlation-dependent collateralized debt obligations (CDO) structures, etc The existence of repeat issuers with large issuance programs and pools of information also helps However, outside the United States, another major change is quietly driving toward more quantitative work: the need to quantify risks in structured finance bonds is moving from the esoteric (for many) area of back-office risk management to front-office investment decision making based on economic and regulatory Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ INDEX types, 434 probabilities credit card asset class and, 691 duration technique and, 41, 43–45 S&P CDO evaluator version and, 403–408 tranche risk measures and, 413–414 rate asset, 595–596 cohort analysis, 37–41 cumulative 36–45 PD, 39 probability of, 40 by industry, 35 recovery modeling and, 459–463 securities value, coverage tests and, 458 sensitivity delta and, 350–358 iOmega, 350–352 omega, 323–326, 352–353 VOD risk per unit carry, 353–358 spread process and, LSS spread triggers, 514–517 time, 400 Deficiencies of correlations, 146–147 Definitions credit card terminology, 738–739 RMBS and, 746–749 Delinquencies, European RMBS tranches and, 562 Delta, 300–311 correlation, 307–308 credit correlation sensitivity, 349–350 default sensitivity, 350–358 monitoring of, 342–358 spread levels, 306–307 sensitivity and, 344–348 function of time, 307 hedged tranches, 313 hedging, 305–309, 323 capital structure, 306 CDS index, 309–310 credit01 sensitivity, 309 –310 MtM single name CDS, 301–302 synthetic CDO, 302–305 neutral long equity tranche, 313–315 senior tranche, 315 771 risk vs credit event risk, 369 single name/individual, 300–301 upfront payments, 308–309 Demand and supply, BIS2 regulations impact on, 24–26 Density, nonparametric estimation and, 500 Dependence joint intensity modeling, 177–180 modeling, evolution of, 180 Dependency correlation, empirical results, 180–212 measures, 137–212 copula, 157–179 correlation, 142–160 credit risk factor models, 148–153 default factor model, 153–157 Gaussian copula, 153–157 rank correlations, 147–148 sources of, 139–141 survival factor model, 153–157 Derivative product companies (DPC), SIV and, 649–652 Deterministic default rate patterns, covered bonds and, 593–594 Directional trades, 388–389 Discounted LGD, 697–698, 727–728 Distribution free distance minimization, 174–176 Diversification CDO investor motivations and, 378 calculations, correlations and, 143–146 multiple assets, 145–146 two asset case, 143–145 Double leverage, synthetic CDO strategies and, 389–390 DPC See derivative product companies Drift commodity transaction pricing and, 501–504 nonparametric estimation and, 500–501 Duration focus, covered bonds and, 606–607 method, 404 models, 201–206 technique credit rating transition probabilities and, 41, 43–45 default probabilities and, 41, 43–45 Dynamic barrier approach, 116–119 CreditGrades, 117 safety barrier, 117–119 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ 772 E Early repayments asset side, 600–601 covered bonds and, 600–601 Economic cycle transition matrices, 36–45 Markov chain, 37 EDF See expected default frequency EDS See equity default swaps Elementary portfolio, CDO trading risk management and, 341 Eligible accounts, RMBS legal issues and, 553–554 Elliptical copula, 161–163 archimedean, 162–163 Gaussian, 161 t-copula, 161–162 Empirical asset implied correlations Bayesian estimation approach, 188–190 calculations of, 180–196 joint default probability approach, 181–185 correlations equity correlations, 190–192 implied asset correlation behaviour, 192–196 maximum likelihood approach, 185–188 copula, 171–172 correlation, CDO tranches and, 206–208 default correlations, joint default probability approach and, 183 matrices, reduced form models and, 102 results, correlation and, 180–212 CDO implications, 206–212 intensity based models, 196–206 Equity based PD models, 63–64 cash flow methodology and, 455 correlations, as proxies, 190–192 credit paradigm to, 120 default events, cohort results, 481–483 swaps (EDS), 480–498 barriers, 492–494 CDO hybrids, case study, 494–498 default events, 481–483 definition of, 192 implied asset correlation behavior, extraction from 192–194 multivariate aspects, 490–494 MLE approach, 491 price dynamics, modeling of, 483–484 INDEX price dynamics empirical results, 489–490 GARCH(1,1), modeling of, 486–487 logit techniques, 487–488 lognormal, modeling of, 484–486 modeling of, 483–484 statistical credit scoring, 487 volatility, yield spread determinants and, 70 Europe CDO new issuance and, structured finance market new issuances and, European ABS analysis, 565–583 RMBS tranches, 554–565 cashflow analysis, 559–565 defaults and losses, 560–561 delinquencies, 562 expenses, 564 interest rates, 562–563 originator insolvency, 563–564 prepayment rates, 562–563 principle deficiencies, 564–565 reinvestment rates, 563 risk, 565 portfolio credit analysis, 554–559 LS calculations, 556–559 Exact maximum likelihood See full maximum likelihood Excess interest valuation, RMBS and, 548–551 Expected case default patterns, 438 Expected default frequency (EDF), 58 Expenses, European RMBS tranches and, 564 Exposure pool type, 18 single name, 18 structured finance markets and, 18 F Fee leg value, 259–260 FF calculations definition of, 555 European RMBS tranches and, 555–556 Financial markets, structured, 1–27 ratios, credit rating scales and, 33 First order spread sensitivity, delta, 300–311 hedging, 309 MtM Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ INDEX single name CDS, 301–302 synthetic CDO, 302–305 single name/individual, 300–301 First passage time models, 115–116 Fixed rate asset mix, 445–446 Fixed recoveries, 408 Floating rate asset mix, 445–446 Foreclosure frequency, rating of RMBS tranches and, 539–542 Foreign currency risk, 448–450 Foreign exchange rates, covered bonds and, 597–607 break even portfolio, 605–606 communication of results, 604–604 duration focus, 606–607 early repayments, 600–601 macroswaps, 601–604 servicing fees, 601 treatment of recoveries, 597–600 quantitative rating eligibility test, 597 Forward dynamics, SPA model and, 273–275 Forward starting CDO, 474–476 Fourier transform techniques, 255–256 Frank copula, 162 Full maximum likelihood, copula statistical techniques and, 168–169 Functional copula, 164–165, 249–250 FX evolution, 641 G Gamma, 311–313 delta hedged tranches, 313 macroconvexity, 312 microconvexity, 312 realized correlation, 316–318 GARCH(1,1), constant drift, modeling of, 486–487 Gaussian copula, 153–157, 161, 246 extension of, 250–251 random factor loadings, 250–251 recovery, 251 model, 401 recursive scheme, 329–331 Gearing, credit CPPI and, 521–524 Gini coefficient, 529 curve, 50–52 coefficient definition, 86–87 GLMM, Bayesian estimation approach and, 188–190 773 Global Cash Flow and Synthetic CDO Criteria, 431, 443 Goodness of fit copula statistical techniques and, 173–176 distribution free distance minimization, 174–176 Granularity, 16 Gumbel copula, 162 H Hair cut, low rated collateral and, 457 Hazard rate models, 93–94 pricing, 93–94 Cox process, 94 inhomogeneous Poisson process, 94 standard Poisson process, 93 term structure, 328–329 Heath, Jarrow and Morton (HJM) framework, 98 Hedge funds, 13–14 attraction to synthetic CDO, 384 Hedging capital structure, 306 delta sensitivity and, 305–309 risk management and, 298–300 tranche positions, 324–326 Heath, Jarrow and Morton (HJM) framework, 98 HG See high grade High grade (HG) arbitrage cash, 10 High yield (HY) arbitrage cash, 10 HJM, Heath, Jarrow and Morton framework, 98 Homogeneity, synthetic CDO types and, 251–253 HY See high yield I IAA See internal assessment approach IFM See inference function for margins iGamma, 312 Implied asset correlation behavior, 192–196 credit events, asset implied correlation extraction, 194–196 duration models, 201–206 EDS, extraction from, 192–194 Implied correlation, 263–272 smile, 264 Independent intensity models, 196–198 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ INDEX 774 Index tranches liquidity, synthetic CDO investor motivation and, 382 Individual asset default behavior, 402 Inference functions for margins (IFM), 169–170 Inhomogeneous Poisson process, 94 Insolvency, European RMBS tranches and, 563–564 Insurance companies, capital requirements and, 27 Intensity based models of credit risk, 196–206 Intensity based models See hazard rate models Intensity models independent 196–198 physical measure, 198–201 Interest income, cash flow methodology and, 450 mismatches, default bias and, 441–442 rate covered bonds and, 596–597 credit CPPI and, 524 European RMBS tranches and, 562–563 sensitivity analysis, 445–446 fixed rate asset mix, 445–446 floating rate asset mix, 445–446 liability indices, 446 loan basis risk, 446 simulation, covered bonds and, 590–593 stresses cash flow methodology and, 444–446 sensitivity analysis, 445–446 specifics of, 445 Internal assessment approach (IAA), 677 Investment banks BIS2 regulations impact on, 22–24 grade credit rating, 31 iOmega default sensitivity and, 350–352 tranche positions and, 324–326 IRB, credit card asset class and, 690 Issue specific credit rating, 31 volumes, structured finance markets and, 1–6 United States, Issuer credit rating, 31 iTraxx, 12 J Jarrow, Lando and Turnbull See JLT JLT (Jarrow, Lando and Turnbull), 98–99 model, 98–99 extentions of, 104–105 Arvanitis et al, 104–105 Das and Tufano model, 104 spreads, derived from, 101 time homogeneous Markov chain, 102–104 Joint cumulative probability calculation, 163–166 functional copula, 164–165 Kendall’s tau, 166 Marshall Olkin copula, 163 Spearman’s rho copula, 166 Joint default behavior, 402 Joint default probability (JPD) approach, 181–185, 230–231 asset implied correlation, 183–185 empirical default correlations, 183 estimating of, 181–185 method, 410–411 default correlation, 410 technique, 187–188 Joint intensity modeling, 177–180 JPD See joint default probability Jump diffusion processes, 106–107, 639–640 MLE calibration, 107 structural models, 119–120 Junior tranches, 17 K Kendall’s Tau, 148 copula and, 166 L Lambda, 311 Latent variables, 401 Legal issues, RMBS and, 551–554 eligible accounts, 553–554 servicer accounts, 553–554 special purpose entities, 552 trustee accounts, 553–554 Leverage CDOs, 13–14 credit CPPI and, 521–524 cross subordination, 473–474 double, 389–390 positions, structured finance markets and, 18 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ INDEX SIV and, 624 squared transactions and, 469–474 super senior (LSS) transactions See LSS synthetic CDO strategies and, 386–387 yield spreads determinants and, 70–71 LGD (loss given default) discounted, 697–698, 727–728 lost severity (LS), 725 non discounted, 694–697, 725–726 RMBS asset class and 725–726 tranche, 414 LGD, See loss given default Liability indices, 446 ratings, default pattern timing and, 435–436 side, cash CDO pricing and, 286–290 Likelihood ratio method, 337–338 Liquidity asset based, 19–20 facilities, SIV and, 657–658 risk, SIV test and, 645–646 structure finance markets and, 14–16 mark to market (MTM) accounting, 14–16 yield spreads and, 74–76 Loan basis risk, 446 Logit techniques, equity price dynamics and, 487–488 Log-likelihood ratio, 52–53 Lognormal constant drift, 484–486 modeling of, 484–486 Long CDO tranche, 419 Long CDS, 418–419 Long dated corporate assets, 451–452 Long/short structures, synthetic CDO and, 476–478 Loss allocation, RMBS senior/subordinate structures and, 547 given default See LGD eg See contingent leg value protection, stepping down of, 547–548 severity (LS), 725 calculations definition of, 555 European RMBS tranches and, 556–559 RMBS tranches rating and, 542–544 Low credit quality portfolios, default patterns and, 440 775 Low rated collateral, hair cut for, 457 LS See lost severity LSS (leverage super senior) spread triggers modeling of average portfolio spread, 510–513 default and spread process, 514–517 PD rating determination, 513 S&P version, 510, 512–513 transactions, 507–517 basic structure, 507–509 protection buyers, 508–509 protection sellers, 508–509 spread triggers, 509–510 modeling of, 510–517 M Macroconvexity, 313–315 delta neutral long equity tranche, 313–315 senior tranche, 315 gamma and, 312 Macroswaps, covered bonds and, 601–604 Mark to market See MtM Market implied ratings, spreads and, 78–80 volatility approach, 113–115 Market risk, 298–300 SIV tests and, 641–642 Markov chain, 37, 102–104 time homogeneous, 103–104, 282 non homogeneous, 281–282 process, 404 Marshall Olkin copula, 163, 248–249 Matrix SIV, 627–641 Maximum likelihood estimator See MLE MBS See mortgage backed securitizations MC simulation brute force, 335–337 CDO sensitivities, 335–338 valuation, 335–338 likelihood ratio method, 337–338 Measuring risk, 296–298 Merton framework extensions of, 115–120 first passage time models, 115–116 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ 776 Merton (Continued) incomplete information, 116 model, 55–58, 108–110 term structure, 64 Method of moments, 611–612 Mezzanine equity positions, 20 loans, corporate, 452 tranche types, 14 Microconvexity, 315–316 iGamma, 312 MLE (maximum likelihood estimator) approach, 185–188 asset-implied correlation calculation, 187–188 equity default swaps and, 491 calibration, 107 covered bonds and, 611 technique, 187–188 Modeling calibration, commodity transaction pricing and, 501–504 SIV, 627–641 structured finance markets criteria and, 19 Monte Carlo approach capital notes and, 662–665 portfolio loss distribution and, 254 Moody’s KMV credit monitor, 58–63 expected default frequency (EDF), 58 rating scales, 31–32 Mortgage assets, treatment of recoveries and, 597–598 backed securitizations (MBS), 16 conforming, 535 nonconforming, 535 residential backed securities, 535–584 MtM (mark to market) 295, 506–526 accounting, violatility of, 14–16 risk credit constant proportional portfolio insurance (CPPI), 517–527 leverage super senior (LSS) transactions, 507–517 sensitivity measures, 299 single name CDS, 301–302 synthetic CDO, 302–305 Multiple assets, 145–146 Multiple defaults, omega and, 324 Multivariate aspects, MLE approach, 491 INDEX N NCO test, 646–648 NIG See normal inverse Gaussian copulas Non conforming mortgages, 535 Non discounted LGD, 694–697, 725–726 Non investment grade credit rating, 31 Non parametric estimation density, 500 drift, 500–501 parametric, 531 volatility/diffusion, 530–531 Normal inverse Gaussian (NIG) copulas, 247–248 nth to default baskets, 419–420 O Omega, 323–326 default sensitivity and, 352–353 hedged tranche positions, 324–326 iOmega, 324–326 multiple defaults, 324 unhedged tranche positions, 324–326 Originator insolvency, European RMBS tranches and, 563–564 structured finance market and, 17–18 Outlook concept, credit ratings and, 34 Overcollateralization break even portfolio and, 605–606 reinvestment test, 457 test, 456–458 breach of coverage tests, 456 P Parallel yield curve shift, SIV tests and, 642–644 Parametric estimation, 531 Pay in kind assets, 451 Payments timing mismatch, 451 upfront, delta and, 308–309 PD (probability of default), 30 credit rating, links between, 34, 36 default rates, cumulative, 39 modeling statistical, 45–55 term structures, 53–55 types, 50–53 Gini curve, 50–52 log-likelihood ratio, 52–53 per rating category, 42 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ INDEX rating determination, LSS spread triggers and, 513 recovery model combination and, 83–84 yield spread determinants and, 68–70 Pension funds, capital requirements and, 27 Pfandbriefe-like covered bonds, 586 Physical measure, intensity models and 198–201 Point by point yield curve shift, SIV tests and, 644 Poisson inhomogeneous process, 94 process, standard, 93 Pool exposure, 18 Portfolio considerations, cash flow methodology and, 447–453 credit analysis, European RMBS tranches and, 554–559 FF calculations, 555–556 LS calculations, 556–559 criteria, structured finance markets and, 16–20 diversification guidelines, SIV and, 618–619 homogeneity, synthetic CDO types and, 251–253 loss distribution, 333 conditional survival probability, possible candidates for, 245–250 Fourier transform techniques, 255–256 Monte Carlo approach, 254 proxy integration, 256–257 recursive approach, 254 synthetic CDO pricing and, 244–263 modeling Schonbucher’s model, 277–278 SPA model, 272–277 synthetic CDO pricing and, 272–278 probabilities, SPA model and, 273–275 process, SPA model and, 275–276 trading risk management, CDO and, 341–342 Premium leg See fee leg value Prepayment rates, European RMBS tranches and, 562–563 risks, ABS and, 568–570 risks, ABS and, modeling of, 570–576 sensitivities, 447–448 777 Pricing commodity transactions and, 500–506 drift, 501–504 empirical results, 501–504 model calibration, 501–504 Cox process, 94 dynamics, equity, 483–484 hazard rate models and, 93–94 inhomogeneous Poisson,94 spot, 505–506 standard Poisson process, 93 Principle deficiencies, European RMBS tranches and, 564–565 Probability of default See PD Proprietary desks, attraction to synthetic CDO, 384 Protection buyers, LSS transactions and, 508–509 sellers, LSS transactions and, 508–509 Protection leg See contingent leg value Proxy integration, 256–257 Public sector assets, treatment of recoveries and, 599 Q Quantitative rating eligibility test, covered bonds and, 597 R Random factor loadings Gaussian copula and, 250–251 stochastic correlation 250 recovery, Gaussian copula and, 251 Rank correlations, 147–148 Kendall’s Tau, 148 Spearman’s Rho, 148 Rated companies, transition and default probabilities, 403–406 duration method, 404 Markov process, 404 transition matrix, 404 method, 403–406 patterns, deterministic default, 593–594 transaction tranching, cycle impact on, 208–210 Rating approach, 31–45 assignment, 468 base approach See RBA Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ 778 Rating (Continued) based reduced form models, 98–105 basic structure, 98–99 models, JLT, 98–99 key assumptions, 98–99 component, covered bonds modeling and, 594–595 constraints, CDO investor motivation and, 376–379 definitions, cash flow methodology and, 433 migration, 217–237 probabilities of, 222–229 structured finance (SF) tranches, 217 RMBS tranches and, Europe and, 554–565 techniques, RMBS tranches and, 537–554 tranche default probability, 468 loss, 468–469 given default, 469 RBA (rating base approach) financial engineering, 678–686 credit card asset class and, 701–702 Real money investors, attraction to synthetic CDO, 384–385 Realized correlation, gamma and, 316–318 Recovery analysis, simulation SIV and, 635–636 assumption matrices, 425–428 fixed, 408 given default (RGD), 80–83 market value See RMV modeling, 459–463 PD model combination and, 83–84 rates, 442–443 yield spread determinants and, 68 risk, 80–83 loss given default (LGD), 80 recovery given default (RGD), 80 S&P CDO evaluator version and, 408–409 timing cash flow methodology and, 442–444 recovery rates, 442–443 specifics of, 444 variable, 408–409 Recursive approach, portfolio loss distribution and, 254 Reduced form models calibration, advanced, 107–108 default only, 95 defaultable HJM/Market, 98 INDEX effectiveness of, 126–127 empirical matrices, 102 hazard rate, 93–94 other types, 100–101 rating based, 98–105 risk neutral transition matrices, 102 spread processes calibration, 105–107 structural, 108–132 univariate pricing and, 92–108 zero-coupon bonds, 99–100 Regime switching models, effectiveness of, 127–132 Reinvestment rates, European RMBS tranches and, 563 test, overcollateralization and, 457 Repayment, early, 600–601 Repo companies, SIV and, 655–657 Residential mortgage backed securities See RMBS RGD See recovery given default Rho base correlation, 323 correlation sensitivity and, 320–323 delta hedging, 323 Risk ABS credit and, 568–570 modeling of, 570–576 prepayment and, 568–570 modeling of, 570–576 aggregation, 369–370 analysis CDS, 418–419 cross subordination, 416–418 nth to default baskets, 419–420 rated overcollateralization, 412 S&P CDO evaluator version and, 411–420 scenario loss rate, 411–412 synthetic CDO squared transactions, 414–416 tranches long position, 419 risk measures, 412–414 short position, 419 assessment, univariate, 29–87 covered bonds and, 589–595 modeling calibration, 592–593 credit CPPI, 524–527 expected performance, 524–526 European RMBS tranches and, 565 loan basis, 446 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ INDEX management aggregation, 369–370 CDO, 295–338 measurement, 297–298 correlation sensitivity, rho, 320–323 credit event vs delta, 369 default sensitivity, omega, 323–326 hedging, 298–300 market risk, 298–300 measurement of, 296–298 sensitivity measures, 298–300 measurement credit spread convexity, gamma, 311–313 synthetic CDO and, 468–469 time delay, theta, 318–320 tranche leverage, lambda, 311 modeling, covered bonds and, interest rate simulation, 590–593 neutral measure, fundamentals of, 132–133 probabilities, spreads, structural reduced form models and, 110–114 transition matrices reduced form models and, 102 time homogeneous Markov chain, 282 nonhomogeneous Markov chain, 281–282 premium, 72 yield spreads and, systemic factors, 72–74 return profiles, CDO investor motivations and, 379 RMBS (residential mortgage backed securities), 217, 535–584 asset class Basel II and, case studies, 720–737 LGD, 725–726 securitization, 728–730 supervisory formula approach, 730–737 cash flow analysis, 548–551 definitions used in, 746–749 excess interest valuation, 548–551 legal issues, 551–554 eligible accounts, 553–554 servicer accounts, 553–554 special purpose entities, 552 trustee accounts, 553–554 residential mortgage backed securities, 535–584 senior/subordinate structures, 545–546 cash flow allocation, 546–547 loss allocation, 547 779 stepping down of loss protection, 547–548 structural considerations, 545–548 tranches ABS, 565–583 default correlations, 579–583 tail risk scenario, 579–583 valuation, 576–579 collateral, 537–538 Europe cashflow analysis, 559–565 defaults and losses, 560–561 delinquencies, 562 expenses, 564 interest rates, 562–563 originator insolvency, 563–564 prepayment rates, 562–563 principle deficiencies, 564–565 reinvestment rates, 563 risk, 565 portfolio credit analysis, 554–559 FF calculations, 555–556 LS calculations, 556–559 rating of, 554–565 legal, 537–538 rating of, 537–554 credit analysis, 538–544 foreclosure frequency, 539–542 loss severity, 542–544 structural analysis, 537–538 RMV (recovery of market value), 95 S S&P (Standard & Poor’s) CDO evaluator version 3, 397–429 cash flow methodology, 430–463 amortizing assets, 453 cash flow analysis, 431–432 corporate mezzanine loans, 452 coupon on assets, 450 coverage tests, 456–463 default 433–442 analysis, 431 assets, forced sale of, 453 recovery modeling and, 459–463 definition of ratings, 433 equity, 455 foreign currency risk, 448–450 interest income, 450 rate stresses, 444–446 long dated corporate assets, 451–452 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ 780 S&P (Standard & Poor’s) (Continued) pay in kind assets, 451 payment timing mismatch, 451 portfolio considerations, 447–453 prepayment sensitivities, 447–448 recoveries, 442–444 senior collateral manager fees, 455 standard default patterns, 434–436 static transactions, 454–455 correlation, 409–411 assumption matrices, 429 joint default probability method (JDP), 410–411 credit curve matrices, 420–424 key points of, 400–403 credit curves, 401 default time, 400 Gaussian copula model, 401 individual asset default behavior, 402 joint default behavior, 402 latent variables, 401 univariate default, 400 recoveries, 408–409 fixed, 408 variable, 408–409 recovery assumption matrices, 425–428 risk analysis, 411–420 CDS, 418–419 cross subordination, 416–418 nth to default baskets, 419–420 rated overcollateralization, 412 scenario loss rate, 411–412 squared transactions, 414–416 tranches long position, 419 risk measures, 412–414 short position, 419 transition and default probabilities, 403–408 rated companies, 403–406 transition matrices, 420–424 credit card model outcome, 744–745 required tranches, 741 stress factors, 742–743, 745 trapping point, 740–741 variables, 741 methodologies, 397–463 model of LSS spread triggers, 510, 512–513 rating INDEX model, credit card tranches, 702–703 scales, 31–32 Safety barrier approach, 117–119 Saw tooth default patterns, 436–437 Scenario loss rate, 411–412 attachment point, 412 Schonbucher’s model, 277–278 Securitization, 700 Basel II, 667–688 treatment of, case studies 689–749 RMBS asset class and, 728–730 Seller’s interest buffer, 708 Senior collateral manager fees, 455 Senior mezzanine equity positions, 20 Senior tranches, 17 Senior/subordinate structures, RMBS and, 545–546 cash flow allocation, 546–547 loss allocation, 547 stepping down of loss protection, 547–548 Sensitivity analysis, interest rate, 445–446 measures, 299–326 first order spread, 300–311 risk management and, 298–300 Servicer accounts, RMBS legal issues and, 553–554 structured finance market and, 17–18 Servicing fees, covered bonds and, 601 SF See structured finance SFA See supervisory formula approach Short CDO tranche, 419 CDS, 418–419 legal final maturity transactions, default patterns and, 440 structure, synthetic CDO and, 476–478 Simulation SIV, 630–637 beta distribution, 636–637 correlated transition, 631–635 recovery analysis, 635–636 Single name CDS, 301–302 exposure, 18 individual, delta and, 300–301 tranche CDO, 12 SIV (structured investment vehicles) AAA rating, meaning of, 617–618 capital adequacy, 624–626 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ INDEX notes, 661–662 CDO assets in, 615 comparison of, 615–616 liabilities in, 615–616 liquidity in, 616 CDPC, comparison of, 654–655 CIR model calibration, 658–661 cost of funds, 623–624 CP conduits assets in, 616 comparison of, 616–617 liabilities in, 617 liquidity in, 617 credit derivative product companies (CDPC), 652–653 definition of, 613–615 derivative product companies (DPC), 649–652 developments in, 648 hedge funds, comparison of, 617 investor range, 619–623 leverage, 624 liquidity facilities, 657–658 managers of, 619–623 matrix vs modeled, 627–641 structured finance issuers, 637–641 modeling approaches, 627 matrix SIVs, 627–641 portfolio diversification guidelines, 618–619 repo companies, 655–657 simulation, 630–637 sponsorship of, 619–623 structured investment vehicles, 613–665 tests, 641–648 liquidity risk, 645–646 market risk, 641–642 NCO, 646–648 parallel yield curve shift, 642–644 point by point yield curve shift, 644 spot foreign exchange, 644–645 Sklar’s theorem, 157–159 Small to mid sized enterprises See SMEs SMEs (small to mid sized enterprises), 406–407 Smoothing default patterns, 438–439 Sovereign securities, 406 SPA model, 272–277 forward dynamics, 273–275 portfolio loss probabilities, 273–275 781 process, 275–276 tranche valuation, 276–277 Spearman’s Rho, 148 copula and, 166 Special purpose entities, RMBS legal issues and, 552 Spot foreign exchanges, SIV tests and, 644–645 pricing, commodity transactions and, 505–506 Spread measures, 371 modeling, spread processes calibration and, 105–106 processes calibration, 105–107 jump-diffusion processes, 106–107 spread modeling, 105–106 triggers, LSS transactions and, 509–510 modeling of, 510–517 Spread/rating arbitrage, CDO issuing and, 375–376 Spreads CDS, 65–80, 76–78 credit CPPI and, 524 default information from, 78–80 JLT model derivation of, 101 market implied ratings, 78–80 risk neutral probabilities and, 110–114 yield, 65–76 Squared transactions extending leverage, 469–474 cross subordination, 473–474 synthetic CDO, 414–416 Standard and Poor’s See S&P Standard Poisson process, 93 Standardized index tranches, correlation trades and, 12–13 CDX, 12 iTraxx, 12 Static transactions, collateral and, 454–455 Statistical PD modeling, 45–55 equity based, 63–64 Merton model, 55–58 Moody’s KMV credit monitor, 58–63 types and techniques, 45–50 Step up transactions, 478 Stepping down of loss protection, RMBS senior/subordinate structures and, 547–548 Stochastic correlation, 250 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ 782 Stress factors, S&P credit card model and, 742–743, 745 Structural analysis, RMBS tranches and, 537–538 reduced form models, 108–132 capital asset pricing model (CAPM), 110–113 dynamic barrier approach, 116–119 equity to credit, 120 hybrid models, 120 jump-diffusion, 119–120 market implied volatility approach, 113–115 Merton framework, extensions of, 115–120 model, 108–110 risk neutral probabilities, spreads, 110–114 Structured covered bonds, 586 Structured finance (SF) issuers asset spread simulation, 638 FX evolution, 641 jump diffusion process, 639–640 SIV and, 637–641 markets BIS2 regulations, impact on, 20–26 CDO, 2, 11 new issuance, United States, commercial mortgage backed securitizations (CMBS), criteria for asset based liquidity, 19–20 BIS2 impact, 18–19 counterparty, 17–18 country specific considerations, 19 credit exposure type, 16–17 cyclical sectors, 20 exposures, 18 granularity, 16 junior tranches, 17 leverage postions, 18 modeling, 19 originator involvement, 17–18 senior mezzanine equity positions, 20 tranches, 17 servicer, 17–18 tructured finance markets, criteria for, third party involvement, 17–18 deal and portfolio criteria, 16–20 developments and trends in, 4–5 INDEX expectations of, 6–8 asset backed securitizations (ABS), issue volumes, 1–6 United States, liquidity of, 14–16 mark to market (MTM) accounting, 14–16 new issuances, Europe, overview of, 1–27 regulatory changes to, 26–27 accounting practices, 26–27 capital requirements, 26–27 shortcomings of, 8–9 products asset-backed securities (ABS), 217 collateralized debt obligations (CDO), 217 residential mortgage backed securities (RMBS), 217 tranches, 217 asset correlation estimates, 233 corporates, comparison of, 232–236 data description, 219–221 regional distribution, 220 quantity by rating, 221 rating migration, probabilities of, 222–229 transition matrix, cohort methods, 223–224 investment vehicles See SIV models effectiveness of, 120–126 reduced form model, effectiveness of, 126–127 regime-switching, 127–132 Student t copula, 246–247 Supervisory formula approach, (SFA), 673–675, 703–708 financial engineering, 678–686 RMBS asset class and, 730–737 Supply and demand, BIS2 regulations impact on, 24–26 Survival copula, 160 Survival factor model, dependency measures and, 153–157 Synthetic CDO, 11–13, 240–241, 373–396, attractions of, 383–386 dealers, 385–386 hedge funds, 384 proprietary desks, 384 real money investors, 384–385 balance sheet type, 11 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ INDEX bespoke synthetic type, 12 cash CDO, comparison of, 380–381 commodity transactions, 498–506 individual prices, 500–506 correlation trades, 12–13 crisis of, 391–394 developments in, 398–399, 465–531 drawbacks of, 383 equity default swaps, 480 general modeling of, 399–400 Gini coefficient, 529 hybrids case study, 494–498 products, 479 investor motivation, 382–383 bespokes flexibility, 382 index tranches liquidity, 382 MtM and, 302–305 risk, 506–526 nonparametric estimation, 530–531 pricing of, 242–279 base correlation, calibration, 268–270 bespoke tranches, 279 cash, 279–282 correlation, 283–286 skew, 270–271 implied correlation, 263–272, portfolio loss distribution, 244–263 modeling, 272–278 unconditional portfolio loss distribution, 258–263 contingent leg value, 258–259 fee leg value, 259–260 illustration of, 260–263 underlying obligors, modeling of, 278 ratings of, 467–460 assignment, 468 forward starting CDOs, 474–476 long/short structures, 476–478 tranche default probability, 468 loss, 468–469 given default, 469 variable subordination, 478 risk measures, 468–469 squared transactions, 414–416, 469–474 standardized tranches, 12 strategies, 386–390 directional trades, 388–389 double leverage, 389–390 relative value trades, 388 783 taking leverage, 386–387 tranches as hedging vehicles, 390 unidirectional trades, 388–389 structured finance type, 11 types portfolio homogeneity, 251–253 portfolio loss distribution, 254–257 variants in, 467–478 Systemic factors, yield spreads and, 72–74 T Tail risk scenario, 579–583 Taxes, yield spreads and, 76 t-copula, 161–162 Term structures Merton model and, 64 PD modeling and, 53–55 Theta, 318–320 Time delay, theta, 318–320 delta and, 307 homogeneous Markov chain, 103–104, 282 nonhomogeneous Markov chain, 102–103, 281–282 series, copula estimation and, 176–177 Timing default patterns and, 434–435 liability ratings effect on, 435–436 Tranche, 12 bespoke CDO, 279 cash CDO pricing and, 288 CDO, 206–208 efault probability, 468 CDO risk management and, 297 delta hedged, 313 neutral long equity, 313–315 senior, 315 hedging vehicles, 390 junior, 17 leverage, lambda, 311 loss 333, 468–469 CDO risk management and, 297–298 given default, 469 CDO risk management and, 298 risk measures and, 414 positions, 419 iOmega and, 324–326 omega and, 324–326 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ INDEX 784 Tranche (Continued) pricing correlation risks, 369 rated transaction, 208–210 risk measures, 412–414 default probability, 413–414 expected tranche loss, 414 loss given default, 414 other types, 414 RMBS, 537–554 S&P credit card model and, 741 senior, 17 structured finance (SF), 217 valuation, SPA model and, 276–277 Transition default probabilities and asset backed securities, 406 equity default swaps, 407–408 rated companies, 403–406 duration method, 404 Markov process, 404 transition matrix, 404 method, 403–406 SMEs (small to mid sized enterprises), 406–407 sovereign securities, 406 matrices, 420–424 matrix, 404 structured finance tranches and, cohort methods, 223–224 method, 403–406 probabilities, S&P CDO evaluator version and, 403–408 Trapping point, 740–741 Treatment of recoveries covered bonds and, 597–600 mortgage assets, 597–598 public sector assets, 599 Trustee accounts, RMBS legal issues and, 553–554 Two asset case, 143–145 Two- factor model, asset correlation and, 231 U Unconditional portfolio loss distribution contingent leg value, 258–259 fee leg value, 259–260 illustration of, 260–263 synthetic CDO pricing and, 258–263 Underlying obligors, synthetic CDO pricing based on, 278 Unhedged tranche positions, omega and, 324–326 Unidirectional trades, 388–389 United States CDO new issuance and, structured finance market issue volumes in, Univariate default, 400 pricing, 91–133 reduced form models, 92–108 risk assessment, 29–87 credit scoring, 45–55 PD and recovery models, 83–84 recovery risk, 80–83 spreads, 65–80 statistical PD modeling, 45–55 V Value on default (VOD), 351 Value trades, synthetic CDO strategies and, 388 Variable recoveries, 408–409 subordination, 478 step up transactions, 478 Variables, S&P credit card model and, 741 Visual comparison, copula statistical techniques and, 173–174 VOD (value on default), 351 risk per unit carry, 353–358 Volatility/diffusion estimation, nonparametric estimation and, 530–531 W Waterfall structure, cash CDO pricing and, 286–289 Withdrawn credit ratings, 41 Y Yield Baa vs Aaa rating, 67–68 curve, yield spreads determinants and, 71 spreads, 65–76 determinants of, 68–76 equity volatility, 70 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/ INDEX leverage, 70–71 PD, 68–70 recovery rate, 68 yield curve, 71 dynamics of, 65–68 Baa vs Aaa yields, 67–68 785 liquidity, 74–76 risk premium, 72 systemic factors, 72–74 taxes, 76 Z Zero-coupon bonds, 99–100 Trắc nghiệm kiến thức Forex : https://tracnghiemforex.com/