Page 6 - FINAL CFA II SLIDES JUNE 2019 DAY 10

LOS 37.a: Explain expected exposure, the loss READING 37: CREDIT ANALYSIS MODELS
given default, the probability of default, and the
credit valuation adjustment.
MODULE 37.2: ANALYSIS OF CREDIT RISK
Relative Credit Risk Analysis
Expected loss combines the PD and loss severity to compare the credit risk of several bonds. All else same, the higher the
expected loss, the higher the credit risk.

EXAMPLE: Relative risk On a relative
evaluation: Elsa Jaitley is basis, which
comparing three corporate bond has the
bonds for inclusion in her highest risk?
fixed-income portfolio. For Based on this
the next year, Jaitley has information, what
collected the following would be an
information on the three appropriate
bonds: trading strategy?

(1 – recovery rate) LGD
exposure) ×
But use PD
exposure – recovery
(per 100)

But exposure and recovery amounts are per $100 par, Bond Z is the most risky while bond Y has the least credit risk.

LGD per $100 par = exposure – recovery (for Can you recommend a trading strategy based only on this
example, for bond Y, LGD = 88 – 45 = $43). information? Buy or sell?
No, because we are not given the market price of the three bonds!