BMA5316A: Risk Management(in Credit)

Summer Elective Course 2010

Ganesh Ramchandran

Please note that ideally this course should be covered in 7 separate lectures of 3 hours each instead of the currently scheduled 6 lectures of 3.5 hours per session. I propose that the course run from6pm to 9pm on six consecutive Tuesdays (11th May through 15th June). On the first day of class on 11th May, we will all agree a time/date for an additional 7th lecture that is most convenient for everyone.

Course Description

“Insider’s View on Credit/Risk Fusion” is perhaps a better title to best describe this course.

The subject matter deals with how “credit” has developed as the dominant asset class in the financial industry and also in academic research. The focus will be on understanding different credit products, both single name and portfolio products, along with an overview of structured credit derivative products. The recent sub-prime triggered financial meltdown in 2007-2009 has exposed major shortcomings in risk assessment by participants all around. The course will also provide insight into the causes of the credit crisis and compare it with other financial crashes.

The emphasis will be on learning simple and complex credit instruments in a non-technical intuitive manner from an industry insider’s standpoint using a “first principles” approach.

Real-life “war stories” from the financial industry will be used whenever possible instead of conventional text-book analysis. In general the focus will not be on overly technical subject material but on practical applications and actual trades put on by banks and hedge funds.

There will be a special case study type discussion of the recent Goldman Sachs fraud charges and the bank’s involvement in CDOs with hedge funds and other market participants.

Students will learn that “informed decision making” usually calls for a balanced approach – quantitative plus an intuitive market “feel” for what can go horribly wrong.

Textbook/Reading Materials–Notes taken from different books and industry research

Recommended Text Book

“Credit Derivatives – A Primer on Credit Risk, Modeling and Instruments”, Chacko, Sjoman, Motohashi & Dessain (Pearson Education Inc. Publishing as WhartonSchool Publishing, 2006)

Additional Readings

“Options, Futures, And Other Derivatives” - Seventh Edition, John C. Hull (Pearson Educational International, Pearson Prentice Hall, 2009)

“Capital Market Instruments – Analysis and Valuation” - Third Edition, Choudhry, James, Landuyt, Pereira, Pienaar, Palgrave MacMillan, 2010)

Recommended readings will be loaded on IVLE or given as handouts

Selected Course Topics (including but not restricted to following)

1) What is Credit Risk – Introduction to Asset Class – uses and abuses

  • Borrowing and Lending – everyone does it
  • Expected Loss, Default Probability and Recovery

2) Introduction to Credit Derivatives: terminology, pricing and real-life trade examples

  • Building blocks – Credit Default Swap
  • Standardised Indices – CDX/Itraxx
  • Tranches and First to Default Baskets

2) Credit Risk Valuation – pros and cons

  • Structural – Merton approach
  • Reduced-Form

3) Spectrum of Credit Derivative Applications

  • Convertible bonds – debt vs equity
  • Credit default options
  • Hedging Counterparty Risk

4) Trading Strategies –

  • Directional
  • Relative value (e.g basis),
  • Portfolio based/structured products

5) Portfolio Credit Products

  • ABCs of “Correlation Trading” in the “City”
  • CDOs – cash vs synthetic
  • Intuition into pricing and mispricing

6) Credit Crisis – From Sub-Prime to Super-Senior

  • What went wrong with Risk Management
  • Compare/contrast toother crashes/risk failures in other markets
  • Students to choose from universe of credit/non-credit crises and present to class

Learning Approach

Excel-based case studies, real-life examples of risk mismanagement in Wall Street, emphasis on “intuitivefeel” to supplement models/usual text-book techniques, group presentations

Grading and Assessment (% below indicative)

50% Final Exam (mainly MCQ)

20% Group Presentation

20% Homework / Case Study Write-ups

10% Class Participation