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0:00
Hello, my name is Marwa Hammam.
I'm the Executive Director
of the Master of Finance Program
at Cambridge University.
In today's talk,
I'm going to be carrying on
form the discussion
that we started
around the credit equation,
looking at probability
of default,
loss given default more closely,
and then, looking at linkages
between credit and market risk,
which are
fundamentally important
as established
by the requirements
under Basel II
and three and beyond.
0:28
So going back to our
discussion last time
on excepted credit loss
and the components
that drive them,
and we've established
those are largely
at the probability of default,
and a very good proxy
for which is the risk creating
of the counterparty.
Loss given default,
which is defined as
one minus the recovery rate.
There are preset parameters,
as I mentioned in the previous talk,
whereby the Basel court
required a 45 percent loss
given default charge
in the event of
collateralized exposure.
And 75 percent
loss given default
for subordinated exposures.
1:06
In the world of credit,
outcomes are fairly binary,
i.e., there is either
a default or no default.
In the event of non-default,
the credit loss is zero
and the probability
of that scenario
unfolding is 1 - PD.
In the event of a default,
the loss amount is quantified by
looking at the loss
given default,
multiplied by
the exposure at default,
which is generally the amount
of exposure on the books
at the point of default.
And the probability
of that scenario is PD.
As you could see on the equation
at the bottom of this slide,
it's very rare that banks
have a single instrument
or single exposure
to one client.
Often, they have
multiple exposures
and the expected
loss for a client
is calculated by looking
at the probability of
default and loss given default
for each piece of exposure.
And that is rolled up into
what is the expected loss
for that client overall,
or for a portfolio of credits
if that same equation is applied
across multiple exposures
and multiple counterparties.
