CAIA - 29 - Hedge Funds: Credit Strategies Flashcards Preview

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Flashcards in CAIA - 29 - Hedge Funds: Credit Strategies Deck (102)
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1

___ ___refers to an economic process in which undesirable outcomes occur when parties to a transaction have asymmetric information.

Adverse selection refers to an economic process in which undesirable outcomes occur when parties to a transaction have asymmetric information.

2

___ ___occurs after an economic transaction is completed and arises when one party to a transaction changes its behavior and the other party bears the consequences.

Moral hazard occurs after an economic transaction is completed and arises when one party to a transaction changes its behavior and the other party bears the consequences.

3

Recovery Rate Equation

PV of sum to be recovered / Exposure at Default (EAD)

4

Loss Given Default (LGD) Equation

Exposure at Default (1 - Recovery Rate)

5

Expected loss given credit risk equation

Loss Given Default (LGD) x Probability of Default (PD)

 

=

 

Exposure at Default (EAD) * (1 - Recovery Rate) * PD

6

The ___ approach to modeling credit risk assumes an explicit relationship between a firm's capital structure and default, and describes the value of a firm's assets as being equal to the value of its equity plus the value of its debt.

The structural approach to modeling credit risk assumes an explicit relationship between a firm's capital structure and default, and describes the value of a firm's assets as being equal to the value of its equity plus the value of its debt.

7

Under the structural approach, the firm's equity is considered a ___ ___on its assets, with a strike price equal the face value of its ___due at ___date.

Under the structural approach, the firm's equity is considered a call option on its assets, with a strike price equal the face value of its debt due at exercise date.

8

The ___-___approach to modeling credit risk models default as an exogenous event driven by a random signal.

The reduced-form approach to modeling credit risk models default as an exogenous event driven by a random signal.

9

The ___ approach to modeling credit risk involves examining the financial data of companies that have defaulted to try and understand their credit risk.

The empirical approach to modeling credit risk involves examining the financial data of companies that have defaulted to try and understand their credit risk.

10

The best known structural credit risk model is the ___ model.

The best known structural credit risk model is the Merton model.

11

Murton Model Equation

Assets = Debt + Equity

12

The Murton Model assumes that default occurs at ___. It also assumes that ___is costless, ___and ___can be traded without friction and that debt is a ___-___bond.

The Murton Model assumes that default occurs at maturity. It also assumes that bankruptcy is costless, debt and equity can be traded without friction and that debt is a zero-coupon bond.

13

Equity in a merton model equation

E = max(A - K, 0)

 

E = Equity

A = Assets

K = Strike

14

Debt in a merton model equation

D = K - max(K - A, 0)

 

D = Debt

K = Strike

A = Assets

15

Black-Scholes Option Pricing Model

16

d = what in black scholes model

17

Probability of Default in the Merton Model Equation

18

Value of Zero Coupon Debt in Merton Model (equation)

19

Spread in Merton Model (Equation)

20

The primary advantage of the ___ model is that it has several intuitive properties and serves as a basis for more complex models.

The primary advantage of the Merton model is that it has several intuitive properties and serves as a basis for more complex models.

21

The Merton model has several shortcomings:

 

1. It's model's parameters are not ___ ___

2. It is not successful as explaining the ___ ___ on ___-___ securities

The Merton model has several shortcomings:

 

1. It's model's parameters are not readily observable

2. It is not successful as explaining the credit spread on short-term securities

22

The Merton model has four important properties:

 

1. Sensitivity to ___

2. Sensitivity to ___ ___

3. Sensitivity to ___

4. Sensitivity to ___ ___

The Merton model has four important properties:

 

1. Sensitivity to maturity

2. Sensitivity to asset volatility

3. Sensitivity to leverage

4. Sensitivity to riskless rate

23

As time to maturity increases, the credit spread ___ initially, but then ___slightly.

As time to maturity increases, the credit spread increases initially, but then declines slightly.

24

As asset volatility increase, the probability of default ___ and the credit spread ___.

As asset volatility increase, the probability of default increases and the credit spread increases.

25

As leverage increases, the default probability ___ and the credit spread ___.

As leverage increases, the default probability increases and the credit spread increases.

26

The ___ model is a structural credit risk model that estimates the credit risk of debt by considering the loan repayment incentive problem from the perspective of the borrowing firm's equity holders.

The KMV model is a structural credit risk model that estimates the credit risk of debt by considering the loan repayment incentive problem from the perspective of the borrowing firm's equity holders.

27

The structural relationship between the MV of a firm's equity and its assets under the KMV model (Equation)

28

Relationship between volatility a firm's assets and equity according to KMV model (equation)

29

The ___ model's default trigger is the face value of the zero coupon bond.

The merton model's default trigger is the face value of the zero coupon bond.

30

The ___ model's default trigger is based on a weighted average of face values of short-term and long-term debt.

The KMV model's default trigger is based on a weighted average of face values of short-term and long-term debt.

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