Summary: Credit Risk Measurement And Management | Harper
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1 Ashcraft: understanding the securitisation of subprime mortgage credit
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Friction between borrower and originator
Predatory lending
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Friction between arranger and third parties (asset manager, warehouse lender, credit rating agency)
Adverse selection; the arranger has more information.
Resolution is colleteral haircuts imposed by the warehouse lender, or due diligence processes.
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Friction between servicer and borrower
Moral hazard (just like normally towards the bank)
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Friction between investor and asset manager
principal-agent problem if the investor does not fully understand the investement strategy.
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Friction between investor and credit rating agencies
Model error
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What is predatory lending?
- Making unaffordable loans based on the assets of the borrower rather than on the ability to repay.
- Inducing borrower to refinance the loan so to charge high fees
- Engaging in fraud or deception
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What is predatory borrowing
Willful misrepresentation of material facts about a real estate transaction.
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2 Culp Chapter 12: Credit derivatives and credit-linked notes
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Six possible ISDA default events
- Bankruptcy
- Failure to pay
- Obligation/cross-default: default on any similar obligation
- Obligation/cross-acceleration:
- Repudiation/Moratirium: the issuer disavows obligation to pay
- Restructuring: could include reduction of payment, lowering seniority of postponement of payment
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Explain an nth to default CDS
Pays off when the nth default occurs in the reference asset portfolio. After this payout the CDS terminates.
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What is an equity default swap
Protection on a stock. Like a market risk or price protection instrument. The trigger is usually something like a price drop in the stock price; usually around 70%.
It compares to a deeply out of the money equity put.
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