Credit risk management

1. Example Index
Copyright 2018 CapitaLogic Limited
Example Description Excel technique
1 Premium bond
2 Discount bond
3 Credit provision and interest income
This Excel workbook is prepared in accordance with
Chapter 16 of the text book
"Managing Credit Risk Under The Basel III Framework, 3
rd
ed"
Authored by :Dr. LAM Yat-fai (林日辉)
Principal, Structured Products Analytics, CapitaLogic Limited
Adjunct Professor of Finance, City University of Hong Kong
Doctor of Business Administration
CFA, CAIA, CAMS, FRM, PRM
Website: https://sites.google.com/site/crmbase
E-mail: crmbasel@gmail.com
Copyright 2018 CapitaLogic Limited

2. Example 1 Premium bond
Period Cash flow Book value
Principal 1,000,000 0 -1,020,000 1,020,000
Interest rate 12% 1 60,000 1,018,463
Interest frequency 2 2 60,000 1,016,839
Interest amount 60,000 3 60,000 1,015,121
4 60,000 1,013,305
Acquisition cost 1,020,000 5 60,000 1,011,384
Book IRR 5.7317% 6 60,000 1,009,354
7 60,000 1,007,207
8 60,000 1,004,937
9 60,000 1,002,537
10 1,060,000 1,000,000
Copyright 2018 CapitaLogic Limited

3. Example 2 Discount bond
Period Cash flow Book value
Principal 1,000,000 0 -980,000 980,000
Interest rate 12% 1 60,000 981,498
Interest frequency 2 2 60,000 983,090
Interest amount 60,000 3 60,000 984,781
4 60,000 986,579
Acquisition cost 980,000 5 60,000 988,490
Book IRR 6.2753% 6 60,000 990,521
7 60,000 992,679
8 60,000 994,972
9 60,000 997,410
10 1,060,000 1,000,000
Copyright 2018 CapitaLogic Limited

4. Example 3 Provision and income
Credit risk Lower Moderate Higher Credit risk Period RM Survival Default Discount Default loss PVEL
Principal 1,000,000 Lower chance chance factor
Interest rate 12% 1 0.5 99.5490% 0.4510% 94.5790% 424,000 1,809
Interest frequency 2 2 1 99.1000% 0.4490% 89.4519% 424,000 1,703
3 1.5 98.6530% 0.4470% 84.6027% 424,000 1,603
Book IRR 5.7317% 4 2 98.2081% 0.4449% 80.0164% 424,000 1,510
EAD 1,060,000 5 2.5 97.7652% 0.4429% 75.6787% 424,000 1,421
6 3 97.3242% 0.4409% 71.5762% 424,000 1,338
LGD 40% 60% 80% 7 3.5 96.8853% 0.4389% 67.6960% 424,000 1,260
PD 0.9% 9% 30% 8 4 96.4483% 0.4370% 64.0262% 424,000 1,186
RM 5 4 3 9 4.5 96.0133% 0.4350% 60.5554% 424,000 1,117
10 5 95.5803% 0.4330% 57.2727% 424,000 1,052
RM-year PVEL 13,998 142,189 378,970
1-year PVEL 3,512 47,145 187,772 Credit risk Period RM Survival Default Discount Default loss PVEL
General provision 3,512 142,189 Moderate chance chance factor
Specific provision 378,970 3 0.5 95.3939% 4.6061% 84.6027% 636,000 24,784
4 1 91.0000% 4.3939% 80.0164% 636,000 22,361
Book value 1,020,000 1,016,839 1,013,305 5 1.5 86.8085% 4.1915% 75.6787% 636,000 20,175
Interest income 58,463 58,282 36,358 6 2 82.8100% 3.9985% 71.5762% 636,000 18,202
7 2.5 78.9957% 3.8143% 67.6960% 636,000 16,422
8 3 75.3571% 3.6386% 64.0262% 636,000 14,817
9 3.5 71.8861% 3.4710% 60.5554% 636,000 13,368
10 4 68.5750% 3.3111% 57.2727% 636,000 12,061
Credit risk Period RM Survival Default Discount Default loss PVEL
Higher chance chance factor
5 0.5 83.6660% 16.3340% 75.6787% 848,000 104,824
6 1 70.0000% 13.6660% 71.5762% 848,000 82,948
7 1.5 58.5662% 11.4338% 67.6960% 848,000 65,637
8 2 49.0000% 9.5662% 64.0262% 848,000 51,939
9 2.5 40.9963% 8.0037% 60.5554% 848,000 41,100
10 3 34.3000% 6.6963% 57.2727% 848,000 32,522
Copyright 2018 CapitaLogic Limited