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Structuring and Pricing Complex Credit Assets with Monte Carlo / @RISK

Structuring and Pricing Complex Credit Assets with Monte Carlo / @RISK. 22.06.2006 – Jörg Günther. EQUITY VS. CREDIT ASSETS. Balance Sheet Assets Current Assests - - - Fixed Assets - -. Cash Flows CF from Operations CF from Investing

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Structuring and Pricing Complex Credit Assets with Monte Carlo / @RISK

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  1. Structuring and Pricing Complex Credit Assets with Monte Carlo / @RISK 22.06.2006 – Jörg Günther

  2. EQUITY VS. CREDIT ASSETS • Balance Sheet • Assets • CurrentAssests--- • Fixed Assets-- • Cash Flows • CF from Operations • CF from Investing • CF from Financing(or: what is left for 1. Debt Service 2. Equity Distributions) • E&L • Equity-- • Debt-- Pricing- models • Asset Markets Equity Stock-Price Debt Debt-Price; CDS

  3. EQUITY VS. CREDIT ASSETS - DERIVATIVES • Equity Derivatives • Vanilla Options(Call/Put) • Complex Options(Barrier, Basket, Cliquet, ...) • Credit Derivatives • Credit Default Swaps(Credit Risk) • CDO-Tranches • other... • Equity and Credit Assets – and their Derivatives - are • structurally different, but are ultimately based on the • same original Cash Flow of an Entity

  4. DIFFERENCES OF EQUITY AND CREDIT ASSETS • Equity Assets • liquid markets • abundant empirical data on • Underlyings • Options • Credit Assets • Illiquid markets • less empirical data, different focus (default/non-default) • Sophisticated Market & Models • Market & Models„work in progress“

  5. S&Ps RATING METHODOLOGY FOR CDO-TRANCHES • Loss Distribution • Monte-Carlo for Synthetic CDO- Structure • PDs • Recovery Rates • Correlation • Cash-Flow-CDO-Application • Scenarios for • Timing of default • Interest rates • Loss-Distribution used as input for cash-flow-model

  6. BASEL II – HOW MONTE CARLO HELPS TO COVER REGULATORY ISSUES • Balance Sheet Bank • Assets • Loans • E&L • Equity • Debt • Basel II • in % of loan • risk-adjusted • Standard • non-specific,i.e. same orstandardizedrisk-weight;on averagemore equiyto be provided • IRB • eg Project Finance: • Based on Monte-Carlo • More specificRating;on averageless equity

  7. PRICING A WIND POWER PROJECT-FINANCE-DEAL • Cash Flow Model • assumptions • Sources / Uses • Operating Cash Flow • Financing Cash Flow • Risk-Parameters • Scenarios (what-if) • Stochastic Assumptions • Monte-Carlo • Expected Loss • Rating-Class Spread-sheet-example: Wind-Power-Project

  8. STRUCTURING A PORTFOLIO LOAN – THE CASH FLOW STRUCTURE • Cash Flow of Underlyings • Timing Assumptions • Stochastic Assumptions • Asset return • Volatility • Correlation • Cash Flow of Financing Structure • Order of financing and repayment/distributions • defining loss / recovery rate Spread-sheet-example: PE-blind-pool

  9. STRUCTURING A PORTFOLIO LOAN – APPLYING MONTE-CARLO FOR THE PRICING • Structuring Parameters • Size of Equity-Tranche • Order of Distributions (Cash-Flow-Waterfall) • Interests • Outputs of Analysis • Expected Loss • Return on Bank‘s Equity • Return on Sponor‘s Equity • Volatility / Risk of Returns • Precise Pricing • Precise Risk-Return-Packaging Spread-sheet-example: PE-blind-pool

  10. FUNCTIONS OF @RISK OFTEN USED • Function • Distributions • Correlation Matrix • Fit to Distribution • D-Uniform-Distribution • Issue / Questions involved • Calculating Risk: Static -> StochasticAnalysis (Scenario -> Monte-Carlo) • Quantifying Diversification:Portfolio-Structures • Analyzing empirical data • Bootstrapping

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