Description
 Risk management and regulation after the 2008 Financial Crisis
Each study group is assigned to a bank as follows and reponsible for summarizing their risk management policies. Your group number can be found in the attached list.
| Group | Bank |
| 1 | Goldman Sachs |
| 2 | UBS |
| 3 | JP Morgan Chase |
| 4 | Citigroup |
| 5 | Barclays Capital |
| 6 | Morgan Stanley |
| 7 | Deutsche Bank |
| 8 | Bank of America |
| 9 | BNP Paribas |
| 10 | Credit Suisse |
Download their 2009 and most recent annual reports (10-K for US firms and
20-F or 6-K for foreign firms) from SEC’s website (https://www.sec.gov/edgar/searchedgar/companysearch.htm Write a short essay describing the approach of the bank is following for risk management. In particular, describe how it computes the various risk measures to respect the Basel regulations.
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2Â Â Â Â Â Â Â Â Bootstrapping a CDS curve
- Recover the hazard rate curve from slide 15 of the notes.
- Use this hazard rate curve to price a 6-year bond on the same companywhich pays 3% coupon every 6 month and has face value $100.
3Â Â Â Â Â Â Â Â Historical vs bond-implied hazard rates
Explain the patterns you see in the table on slide 16 of the notes.
4Â Â Â Â Â Â Â Â Â Optional: Dynamic credit model
Consider 8 categories: AAA, AA, BBB, BB, B, CCC and default. We are interested in constructing a stochastic dynamic model of rating and default in continuous time. For this we will use the information in slide 7 of the notes.
- Let us call P(t) the 8 × 8 matrix of transition probability after time t. This means that Pij(t) is the probability of being in category j at date t if the firm is in category i at date 0.
(a) What is P(0)? (b) What is P(1)?
- Just like we defined the hazard rate has the instantaneous probability ofdefault, we can consider instantaneous transition probability λij such that λijdt is the probability of going from rating i to rating j during an interval dt if i 6= j. When i = j, we define λii as the opposite of the intensity of leaving state i: λii = −Pj6=i λij. We can put all these in a matrix Λ. Express Λ as a function of P and its first derivative.
- Assuming that Λ is constant over time, derive an expression relating P(1) and Λ.
- Compute Λ for the values of slide 7.
- Use this matrix Λ to compute the probabilities of default at horizon 1, 2,3, 4, 5, 7, and 10 years given each initial rating.
- Compare your results to slide 6 of the notes. What can explain the similarities and differences?
- Use this model to price a 6-year bond on a BBB company which pays 3%coupon every 6 month and has face value $100. Assume that the risk-free interest rate is 0% and recovery is 60%
- Compute the 3, 5, and 10-year CDS spreads for the same company.
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