This course addresses the management of credit risk from the perspective of the total credit portfolio. Building on the concepts of default probability and expected loss for an individual credit instrument, the program provides an overview of the traditional ratings based approach to credit analysis and management, and explains how the traditional approach augments and complements a portfolio approach. The principles of portfolio theory are extended to the management of credit risk. The role of correlation and portfolio diversification are discussed, and the challenges of applying these principles in the context of the credit portfolio are examined.

The concept of debt and equity as options on the assets of the firm is introduced and developed as the basis for the options-theoretic model of default probability for the individual firm. Utilizing Black-Scholes and Merton options models, the conceptual methodology for the determination of distance to default and default probability is developed; a specific example is used to illustrate the concepts. The application of these tools to the measurement and management of the credit portfolio is discussed. The KMV and other methodologies are examined, and their approaches to the analysis are compared and contrasted. Particular attention is paid to the role of Value-at-Risk (VaR) as a risk measurement and management methodology. Credit derivative products and other risk mitigation techniques are addressed.

The course discusses how credit portfolio risk management and VaR techniques are used in an integrated approach to risk management that market and operational risks as well as the management of bank capital and return on risk-adjusted capital. There is a discussion of the economic capital and credit risk capital requirements under the Basel Accords, and the implications of the Accords for credit portfolio risk management.

Objectives

Upon completion of the course, the participant will be able to:

• Calculate portfolio risk for a simple security portfolio
• Explain the components of default probability and loss given default
• Calculate the expected loss on a credit instrument
• Understand and explain the concept of debt as a put option on the firm's assets
• Use the Black-Scholes model to estimate firm asset value and volatility
• Explain the features of the distribution of default probabilities
• Define the marginal risk contribution for a particular asset in a portfolio
• Understand and estimate the premium on a credit derivative product
• Define Value-at-Risk and calculate VaR for a specific credit portfolio
• Explain and calculate the economic capital requirement for a specified level of confidence

This course is for people who are new to the areas of credit portfolio risk, portfolio risk management, and credit value at risk.