2017cfa二级前导固定收益

TopicWeightingsinCFALevelII

TOPICAREA

LEVELⅠ

LEVELⅡ

EthicalandProfessionalStandards(total)

15

10-15

QuantitativeMethods

12

5-10

Economics

10

5-10

FinancialStatementAnalysts

20

15-20

CorporateFinance

7

5-15

InvestmentTools(total)

64

40-70

AnalysisofEquityInvestments

10

15-25

AnalysisofFixedIncomeInvestments

10

10-20

AnalysisofDerivatives

5

5-15

AnalysisofAlternativeInvestments

4

5-10

AssetValuation(total)

29

35-70

PortfolioManagement(total)

7

5-10

TOTAL 100 100

Framework

FixedIncome

R35Thetermstructureandinterestratedynamics

R36Thearbitrage-freevaluationframework

R37Valuationandanalysis:BondswithEmbeddedOptions

R38CreditAnalysisModels

R39Creditdefaultswaps

Framework

BondswithEmbeddedOptions

YieldCurve

YieldSpread

BondValuation

InterestRateRiskAnalysis

CreditRiskAnalysis

CreditDefaultSwaps

BondswithEmbeddedOptions

FixedIncome

Callablebond

Callprovisionsarebeneficialtotheissuer.

Callablebondoffersahigheryield(lowerprice)thanidenticalnoncallablebond

Valuecallablebond=valueofidenticalnoncallablebond-calloptionvalue

Ifinterestratesfall

Issuercanretirethebond,andreplaceitwithlowercouponbonds.

Threestylesofexerciseforcallablebonds:

Americanstyle:canbecalledanytimeafterthefirstcalldate.

Europeanstyle:canonlybecalledonthecalldatespecified.

Bermudastyle:canbecalledonspecifieddatesafterthefirstcalldate,oftenoncouponpaymentdates.

Thepriceappreciationofcallablebondislimited.

Putablebond

Putablebondsarebeneficialtothebondholders.

Ifinterestratesrise

Thebondholderscansellthebondbacktotheissuerandgetcash.

Whenthebondisput,theproceedscanbereinvestedatahigherinterestrate.

Putablebondshavealoweryieldandhigherpricethansimilarnon-putablebonds.

Valueofputablebonds=valueofanidenticalnonputablebonds+putoptionvalue.

Effectofvolatilityonthearbitrage-freevalueofanoption

Interestratevolatilityeffectonthevalueofacallableorputablebond:

Thevaluesofcallandputoptionsincreasewheninterestratevolatilityincreases

Thevalueofacallablebonddecreases

Thevalueofaputablebondincreases

Thevalueofastraightbondisunaffectedbychangesinthevolatilityofinterestrate

volatilitychangeoptionvaluechangebondprice/valuechange

Aconvertiblebondincludesanembeddedcalloption.Theoptionisslightlydifferentfromtheembeddedoptioninacallablebond.

Theconvertiblebondholderownsthecalloption,theissuerownsthecalloptioninacallablebond.

Theholderhastherighttobuyshareswithabondthatchangesinvalue,notwithcashatafixedexerciseprice.

Convertiblebondsarebeneficialtothebondholders.

Valueconvertiblebond=valueofidenticalnoncallablebond+calloption(onstock)value

Keytermsofconversionprovision:

Conversionprice:sharepricewhentheconvertiblebondcanbeconvertedintoshares.

Conversionratio:thenumberofcommonshareseachbondcanbeconvertedinto.

Conversionratio=parvalue/conversionprice

Conversionvalue:valueofconversionbondifconvertedrightnow.

Conversionvalue=currentshare*conversionratio

Conversionpremium:differencebetweentheconvertiblebond’spriceandconversionvalue

Conversionparity:

Parity:conversionvalue=convertiblebond’sprice

Aboveparity:conversionvalue>convertiblebond’sprice

Belowparity:conversionvalue<convertiblebond’sprice

Valuationofconvertiblebond

Noncallable/nonputableconvertiblebondvalue

=Straightvalueofbond

+Valueofthecalloptiononthestock

Mostconvertiblebondsarecallable,givingtheissuertherighttocalltheissuepriortomaturity.

Callableconvertiblebondvalue

=Straightvalueofbond

+Valueofthecalloptiononthestock

-Valueofthecalloptiononthebond

Callableandputableconvertiblebondvalue

=Straightvalueofbond

+Valueofthecalloptiononthestock

-Valueofthecalloptiononthebond

+Valueoftheputoptiononthebond

Stockpricevolatility↓=>Valueofthecalloptiononthestock↓=>convertiblebondvalue↓

Stockpricevolatility↑=>Valueofthecalloptiononthestock↑

=>convertiblebondvalue↑

Stockprice↓=>thereturnsonconvertiblebondsexceedthoseofthestock

Reason:Theconvertiblebond’spricehasafloor=itsstraightbondvalue.

Stockprice↑=>thebondwillunderperform

Reason:conversionpremium.

Stockpriceremainsstable=>thereturnsonconvertiblebondsexceedthoseofthestock

Reason:Thecouponpaymentsreceivedfromthebond,assumingnochangeininterestratesortheyieldorcreditriskoftheissuer.

Floating-RateBond

CouponRate

quotedmargin

referencerate

T

Couponrate= +

Suchas:

LIBOR;

U.S.Treasuryyield

Itisaconstantvalue.

Itisoftenquotedinbasispoint.

Occasionally,thespreadisnotfixe,calledvariable-ratenote.

Thecouponratedeterminedatthecouponresetdateistheratethattheissuerpromisestopayatthenextcoupondate.

Thenew1-yearrateatthattimewilldeterminetherateofinterestpaidattheendofthenextyear.Mostfloaterpayquarterlyandarebasedonaquarterly(90-day)referencerate.

Thereferenceratemustmatchthefrequencywithwhichthecouponrateonthebondisreset.

Floaterwithcapandfloor

Floatingratebond(floater):

Optionsinfloating-ratebonds(floaters)areexercisedautomaticallydependingonthecourseofinterestrates—thatis,ifthecouponraterisesorfallsbelowthethreshold,thecaporfloor

Thecappedfloaterprotectstheissueragainstrisinginterestratesandisthusanissueroption

Valueofcappedfloater=Valueof‘straight’bond–Valueofembeddedcap

Thefloorfloaterprotectstheinvestoragainstdecliningandthusoffersprotectionfromfallinginterestrates

Valueofflooredfloater=Valueof‘straight’bond+Valueofembeddedfloor

YieldCurve

FixedIncome

YieldCurve

Yieldcurveshowsthetermstructureofinterestratesbydisplayingyieldsacrossdifferentmaturities.

Spotcurve

Forwardcurve

Yieldcurveforcouponbonds

Parcurve

SpotCurve

Aspotinterestrate(spotrate)isarateofinterestonasecuritythatmakesasinglepaymentatafuturepointintime.

Discountfactor:thediscountfactor,P(T)

P(T) 1

1r(T)T

Spotyieldcurve(spotcurve):thespotrate,r(T),forarangeofmaturitiesinyearsT>0

Theannualizedreturnonanoption-freeanddefault-risk-freezero-couponbond(zeroforshort)withasinglepaymentofprincipalatmaturity.

Theshapeandlevelofthespotyieldcurvearedynamic

ForwardRates:borrowing/lendingrateforaloantobemadeatsomefuturedate.Marginalreturnforextendingthetime-to-maturityforanadditionalperiod

E.g.Theint.ofa1-yearloanthatwouldbemade2yearsfromnow.Notation:f(2,1)rateofa1-yearloantobemade2yearsfromnow.

Forwardratesmodel(therelationshipbetweenspotrateandforwardrate):

1r(T*T)(T*T)1r(T*)T*1f(T*,T)T

DiscountFactor:F(T*,T)

F(T*,T) 1

1f(T*,T)T

F(T*,T)theforwardpriceofa$1parzero-couponbondmaturingattimeT*+TdeliveredattimeT*

F(T*,T)thediscountfactorassociatedwiththeforwardrate

Forwardcurve:Thetermstructureofforwardratesforaloanmadeonaspecificinitiationdate.

Forwardpricingmodel:

Describesthevaluationofforwardcontracts.

Theno-arbitrageargumentthatisusedtoderivethemodelisfrequentlyusedinmodernfinancialtheory

Tradablesecuritieswithidenticalcashflowpaymentsmusthavethesameprice.Otherwise,traderswouldbeabletogeneraterisk-freearbitrageprofits.

Applyingthisargumenttovalueaforwardcontract

PT*TPT*FT*,T

ForwardcontractpricethatdeliversaT-year-maturitybondattimeT*

ForwardPricingModel

usingforwardpricingmodel

F T*,T

PT*T

PT*

Yieldcurveforcouponbonds

YieldtoMaturity(YTM):Internalrateofreturn,impliedmarketdiscountrate

Calculation:iteration,backout

Annual-couponbond

bondprice= CPN1 + CPN2 +

(1+YTM) (1+YTM)2

Criticalassumptions:

holdthebonduntilmaturity

full,timelycoupon,principalpayments(nodefault)

couponsarereinvestedatoriginalYTM

YieldcurveforcouponbondsshowstheYTMforcouponbondsatvariousmaturities,whichcanbecalculatedbylinearinterpolation

Realizedreturnonabond

Threesourcesofreturn:

Couponandprincipalpayments

Reinvestmentofcouponpayments

Capitalgainorlossifbondissoldbeforematurity

Totalreturn:futurevalueofreinvestedcouponinterestpaymentsandthesaleprice(parvalueifthebondisheldtomaturity)

Annualizedholdingperiodreturn:calculatedasthecompoundannualreturnearnedfromtheholdingperiod.

annualzedholdingperiodreturn=(totalreturn)1n1

bondprice

Parcurve

Theparcurverepresentstheyieldstomaturityoncoupon-payinggovernmentbonds,pricedatpar,overarangeofmaturities.

recentlyissued("ontherun")bondsaretypicallyusedtocreatetheparcurvebecausenewissuesaretypicallypricedatorclosetopar.

Thezero-couponratesaredeterminedbyusingtheparyieldsandsolvingforthezero-couponratesonebyone,inorderfromearliesttolatestmaturities,viaaprocessofforwardsubstitutionknownasbootstrapping.

YieldSpread

FixedIncome

YieldSpread

Benchmarkspread:ayieldspreadrelativetoabenchmarkbond.

G-spread:thebenchmarkisgovernmentbondyield

Interpolatedspread(I-spread):thebenchmarkisswaprate

Zero-volatilityspread(Z-spread):thespreadthatmustbeaddedtoeachrateonthebenchmarkyieldcurvetomakethepresentvalueofabondequaltoitsprice.

G-Spread

Bond

Couponrate

Time-to-maturity

Price

U.K.GovernmentBenchmarkBond

2%

3years

100.25

U.K.CorporateBond

5%

3years

100.65

Bothbondspayinterestannually.Thecurrentthree-yearEURinterestrateswapbenchmarkis2.12%.TheG-spreadinbasispoints(bps)ontheU.K.corporatebondisclosestto:

264bps.

285bps.

300bps.

Correctanswer:B

6%Zbondarecurrentlyyield2.35%andmaturein1.6years.ComputetheI-spreadfromtheprovidedswapcurve

Tenor

Swaprate

0.5

1.00%

1

1.25%

1.5

1.35%

2

1.50%

CorrectAnswer:

Linearinterpolation:

1.6yearswaprate=1.5yearswaprate+0.10(1.50-1.35)

0.50

=1.38%

I-Spread

I-spread=yieldonthebond-swaprate=2.35-1.38=0.62%

I-spreadonlyreflectscompensationforcreditandliquidityrisks.

Z-Spread

Z-spread:spreadwhenaddedtoeachspotrateonthedefault-freespotcurvemakesthepresentvalueofabond’scashflowsequaltothebond’smarketprice,aspreadovertheentirespotratecurve

Zerovolatility:assumptionofzerointerestratevolatility.

Z-spreadisnotappropriateforvaluingbondswithembeddedoptions.

Example:

one-yearspotrateis4%andthetwo-yearspotrateis5%.Themarketpriceofatwo-yearbondwithannualcouponpaymentsof8%is

$104.12.TheZ-spreadisthespreadthatbalancesthefollowing

equation:

$104.12 $8 $108(10.04Z) (10.05Z)2

Option-adjustedspread(OAS):usedforbondswithembeddedoptions.

Callablebond:ZS>OAS

Putablebond:ZS<OAS

Optioncost=Z-spread–OAS

Anoption-adjusted-spread(OAS)onacallablebondistheZ-spreadminusthevalueoftheembeddedcalloptionexpressedinbasispointsperyear.

Anoption-adjusted-spread(OAS)onaputablebondistheZ-spreadplusthevalueoftheembeddedcalloptionexpressedinbasispointsperyear.

G/Zspread

Optionrisk

Liquidityrisk

OAS

Creditrisk

CallableBond

Treasury(riskfree)

Arbitrage-FreeValuation

FixedIncome

Arbitrage-freevaluation:anapproachtosecurityvaluationthatdeterminessecurityvaluesthatareconsistentwiththeabsenceofarbitrageopportunities.

Arbitrageopportunitiesareopportunitiesfortradesthatearnrisklessprofitswithoutanynetinvestmentofmoney.

Arbitrageopportunitiesariseasaresultofviolationsofthelawofoneprice.

Thelawofonepricestatesthattwogoodsthatareperfectsubstitutesmustsellforthesamecurrentpriceintheabsenceoftransactioncosts.

Wellfunctioningmarketcomplieswithprincipleofnoarbitrage.

Anyfixed-incomesecurityshouldbethoughtofasapackageorportfolioofzero-couponbondsusingthearbitrage-freeapproach.

Stripping:ThemarketmechanismforUSTreasuriesthatenablesthisapproachisthedealer'sabilitytoseparatethebond'sindividualcashflowsandtradethemaszero-couponsecurities.

Reconstitution:dealerscanrecombinetheappropriateindividualzero-couponsecuritiesandreproducetheunderlyingcouponTreasury

Thearbitrage-freevaluationapproachdoesnotallowamarketparticipanttorealizeanarbitrageprofitthroughstrippingandreconstitution

Arbitrage-freevaluation

Afundamentalprincipleofvaluationisthatthevalueofanyfinancialassetisequaltothepresentvalueofitsexpectedfuturecashflows.

Thisprincipleholdsforanyfinancialassetfromzero-couponbondstointerestrateswaps.Thus,thevaluationofafinancialassetinvolvesthefollowingthreesteps:

Step1Estimatethefuturecashflows.

Step2Determinetheappropriatediscountrateordiscountratesthatshouldbeusedtodiscountthecashflows.

Step3CalculatethepresentvalueoftheexpectedfuturecashflowsfoundinStep1byapplyingtheappropriatediscountrateorratesdeterminedinStep2.

Spotrates:aremarketdiscountratesforsinglepaymentstobemadeinthefuture.

Theno-arbitragepriceofabondiscalculatedusingspotrates:

+ 2

no-arbitrageprice=CPN1 CPN2

(1+S) (1+S)

CPNN+Par(1+S )N

+……+

1 2 N

Example:Treasuryspotrates(expressedassemiannual-pay)areasfollows:6months=4%,1year=5%,1.5year=6%.A1.5-year,4%Treasurynoteistradingat$965.thearbitragetradeandarbitrageprofitare:

Buythebond,sellthepieces,earn$7.09perbond

Sellthebond,buythepieces,earn$7.09perbond

Sellthebond,buythepieces,earn$7.91perbond

CorrectAnswer:A

optionfree;2years;annualcouponrateof7%

???

7.1826%

？？？(Today)4.5749%

???

5.321%

(Year1)

100

7

100

7

100

7

（Year2）

CorrectAnswer:

？？？

4.5749%

99.830

7.0

7.1826%

101.594

7.0

5.321%

100

7.0

100

7.0

100

V 1

(1007)

1(1007)

/(17.1826%)$99.830

7.0

1,U 12

V

(1007)

2

1

(1007)/(15.3210%)$101.594

1,L 2 2

V1(99.8307)1(101.5947)/(14.5749%)$102.999

0 2 2

Arbitrage-freevaluation

Zero-couponyieldcurve:Eachknownfuturecashflowisdiscountedattheunderlyingspotrate(alsoknownasthezero-couponyield)

Comparisonbetweenzero-couponyieldcurveandbinomialtree

Valuebondswithembeddedoptions,theratesneedtobeallowedtofluctuate

Thefuturecashflowsareuncertainastheydependonwhethertheembeddedoptionwillbeinthemoney

Thevalueoftheoptiondependsonuncertainfutureinterestrates,theunderlyingcashflowsarealsodependentonthesamefutureinterestrates.

InterestRateRisk

FixedIncome

InterestRateRisk

Interestrisk

利率风险：即债券价格对利率变化的敏感程度，价格对利率变化越敏感，价格波动的可能性就越高

通常用久期duration来衡量利率风险，久期越高，利率风险越高

duration-percentagechangeinbondprice

yieldchangeinpercent

Exercise:Abondhasadurationof7.2,iftheyielddecreasesfrom8.3%to7.9%,calculatetheapproximatepercentagechangeinthebondprice

Percentagepricechange=-duration×yieldchangein%

CalculationofDuration

n

Macaulayduration

t1tPVCFt

n

[t(PVCFt

/P0)]

Duration

PVCFt(P0) t1

Modifiedduration= Macaulayduration

1+periodicmarketyield

Effectiveduration= V--V+

2创V0 Dcurve

Effectivedurationandmodifiedduration

Themodifiedduration:conventionalyielddurationstatistic,measuressensitivityofthebondpricewithrespecttothebond'sownyield-to-maturity.

Effectiveduration:curveduration,measuresthepricesensitivitywithrespecttochangesintheU.S.Treasuryparcurve.

Foratraditionaloption-freebond:

Themodifieddurationandeffectivedurationonatraditionaloption-freebondarenotidentical.

Thedifferencenarrowswhentheyieldcurveisflatter,thetime-to-maturityisshorter,andthebondispricedclosertoparvalue(sothatthedifferencebetweenthecouponrateandtheyield-to-maturityissmaller).

Themodifieddurationandeffectivedurationonanoption-freebondareidenticalonlyintherarecircumstanceofanabsolutelyflatyieldcurve.

Interpretingduration:

Durationistheslopeoftheprice-yieldcurveatthebond’scurrentYTM.(thefirstderivativeoftheprice-yieldcurvewithrespecttoyield)

Durationisaweightedaverageoftime(inyears)untilcashflowwillbereceived.Theweightsaretheproportionsofthetotalbondvaluethateachcashflowrepresents.

Durationistheapproximatepercentagechangeinpriceof1%changeinyield.(pricesensitivity)

Effectsofbondcharacteristicsonduration：

Longermaturity,higherduration.

Lowercoupon,higherduration.

Lowermarketyield,higherduration

Bondwithembeddedoptions(callablebond&putablebond)haslowerduration.

Comparisonofeffectivedurationsamongcallable,putableandstraightbonds

Effectiveduration(callable)≤effectiveduration(straight)

Effectiveduration(putable)≤effectiveduration(straight)

Effectiveduration(zero-coupon)≈maturityofthebond

Effectivedurationoffixed-ratebond<maturityofthebond

Effectivedurationoffloater≈time(years)tonextreset

Levelofinterestrates

Interestratedeclines:thevalueofacallablebondriselessrapidlythanthevalueofanotherwise-equivalentstraightbond

Interestrateincrease:thevalueofaputablebondfallslessrapidlythanthevalueofanotherwise-equivalentstraightbond

Shapeoftheyieldcurve

Calloption

Interestratedecline,thevalueofanembeddedcalloptionincreases

Putoption

Interestrateincreases,thevalueofaputoptionincreases

Effectivedurations:normallycalculatedbyaveragingthechangesresultingfromshiftingthebenchmarkyieldcurveupanddownbythesameamount.

Thiscalculationworkswellforoption-freebonds

Inthepresenceofembeddedoptions,theresultscanbemisleading.

Theproblemisthatwhentheembeddedoptionisinthemoney,thepriceofthebondhaslimitedupsidepotentialifthebondiscallableorlimiteddownsidepotentialifthebondisputable.

Thepricesensitivityofbondswithembeddedoptionsisnotsymmetricaltopositiveandnegativechangesininterestratesofthesamemagnitude.

One-sideddurations:durationsthatapplyonlywheninterestratesgoup(or,alternatively,onlywhenratesgodown.

betteratcapturingtheinterestratesensitivityofacallableorputablebondthanthe(two-sided)effectiveduration

Whentheunderlyingoptionisat(ornear)money,callablebondswillhavelowerone-sideddown-durationthanone-sidedup-duration;thepricechangeofacallablewhenratesfallissmallerthanthepricechangeforanequalincreaseinrates.

Conversely,aputablebondwillhavelargerone-sideddown-durationthanone-sidedup-duration.

PortfolioDuration

PortfolioDuration

TheMacaulayandmodifieddurationsfortheportfolioarecalculatedastheweightedaverageofthestatisticsfortheindividualbonds.Thesharesofoverallportfoliomarketvaluearetheweights.

Portfolioduration=w1D1+w2D2+……+wnDn

Themainadvantagetothesecondapproachisthatitiseasilyusedasameasureofinterestraterisk.

Limitations:themeasureofportfoliodurationimplicitlyassumesa

parallelshiftintheyieldcurve.

Aparallelyieldcurveshiftimpliesthatallrateschangebythesameamountinthesamedirection.

Inreality,interestratechangesfrequentlyresultinasteeperorflatteryieldcurve.(non-parallelshifts→keyrateduration)

YieldCurveRisk

Yieldcurverisk:risktoportfoliovaluearisingfromunanticipatedchangesintheyieldcurve,canbemanagedonthebasisofseveralmeasuresofsensitivitytoyieldcurvemovements

Managingyieldcurverisk

Effectiveduration:measuresthesensitivityofabond'spricetoasmallparallelshiftinabenchmarkyieldcurve

Addressriskassociatedwithparallelyieldcurvechanges

keyrateduration:measuresabond'ssensitivitytoasmallchangeinabenchmarkyieldcurveataspecificmaturitysegment

allowsidentificationandmanagementof"shapingrisk"—thatis,sensitivitytochangesintheshapeofthebenchmarkyieldcurve

Keyrateduration

Durationisanadequatemeasureofbondpriceriskonlyforsmallparalleledshiftsintheyieldcurve.

Akeyratedurationisdefinedastheapproximatepercentagechangeinthevalueofabondorbondportfolioinresponsetoa100basispointchangeinthecorrespondingkeyrate,holdingallotherratesconstant.(fornon-parallelshifts)

Example:

Bond

(zerocoupon)

Weight

D1

D2

D3

D4

KeyRateDuration

2year

10

2

0.2

10year

20

10

2.0

20year

40

20

8.0

25year

30

25

7.5

Portfolio

100

17.7

Example:non-parallelshift

Bond(zerocoupon)

Weight

D1

D2

D3

D4

KeyRateDuration

Shifts

Changesinvalue

2year

10

2

0.2

+1%

-0.2%

10year

20

10

2.0

+1.5%

-3.0%

20year

40

20

8.0

+0.8%

-6.4%

25year

30

25

7.5

-1%

7.5%

Portfolio

100

17.7

-2.1%

Convexityisameasureofthecurvatureoftheprice-yieldcurve.

Themorecurvedtheprice-yieldrelationis,theworseourduration-basedestimatesofbondpricechangesinresponsetochangesinyieldare DP

=[-

P

MD碊( y)]+

轾犏臌0.5创Conv (Dy)2

Theconvexityadjustmentisalwayspositivewhenconvexityispositive

ForanOption-freebondtheprice-yieldcurveisconvextowardtheorigin

Pricefallsarateasyield

Callable

Putable

price/yieldrelationshipwillbemoreconvexwhenyieldincrease

Price(%ofPar)

Calloptionvalue

Price

102

Callablebond

Option-freebond

Option-freebond

putablebond

Valueoftheputoption

YieldNegativeconvexity y’PositiveConvexity

Yield

y’

Comparisonamongeffectiveconvexitiesofcallable,putableandstraightbonds

Straightbondshavepositiveeffectiveconvexity

Theincreaseinthevalueofanoption-freebondishigherwhenratesfallthanthedecreaseinvaluewhenratesincreasebyanequalamount

Callablebondsareunlikelytobecalledandwillexhibitpositiveconvexitywhenratesarehigh

Theeffectiveconvexityturnsnegativewhentheunderlyingcalloptionisnearthemoney

Theupsidepotentialofthebond’spriceislimitedduetothecall(whilethedownsideisnotprotected)

Putablebondsexhibitpositiveconvexitythroughout

CreditRisk

FixedIncome

Creditriskistheriskassociatedwithlossesstemmingfromthefailureofaborrowertomaketimelyandfullypaymentsofinterestorprincipal.Creditriskdependson:

Probabilityofdefault,ordefaultprobability,istheprobabilitythataborrowerdefaults–thatis,failstopayinterestorrepayprincipalwhendue.

lossgivendefault,intheeventofdefault,istheportionofabond’s

value(includingunpaidinterest)aninvestorloses.

Recoveryrateisthepercentageoftheprincipalamountrecoveredintheeventofdefault.Lossgivendefault(%)=100-recoveryrate

Expectedloss=Defaultprobability*Lossseveritygivendefault

Dependsonthestateoftheeconomy:duringboomtimes,theprobabilityofdefaultandlossgivendefaultwillbelower

CapitalStructure:thecompositionanddistributionacrossoperatingunitsofacompany’sdebtandequity,includingbankdebt,bondsofallseniorityrankings,preferredstock,andcommonequity.

FirstLienLoan

SeniorityRanking

SeniorUnsecured

SeniorSecured

Subordinated

SeniorSubordinated

JuniorSubordinated

ThefourCsofcreditanalysis

Capacityreferstotheabilityoftheborrowertomakeitsdebtpaymentsontime.

Collateralreferstothequalityandvalueoftheassetssupportingthe

issuer’sindebtedness.

Covenantsarethetermsandconditionsoflendingagreementsthattheissuermustcomplywith.

Characterreferstothequalityofmanagement

Creditscoringmodel

Ordinalrankingsjustcategorizeborrowerfromhighesttolowestrisk,butdonotindicatethedegreetowhichthecreditriskdiffers.

E.g.Acreditscoreof450isnotequaltohalfthecreditriskofanindividualwithacreditscoreof900.

Creditscoringisusedforsmallbusinessesandindividuals.Characteristicsofcreditscoring:

Creditscoresareordinalrankings.

Notpercentilerankings,andthedistributionofcreditscoreschangeovertime.

Donotexplicitlytakeintoaccountcurrenteconomicconditions.i.e.donotimprovewiththeeconomy.

Pressurefromusersofcreditscores(lenders)toprioritizestabilityinscoresovertime

Donottakeintoaccountdifferingprobabili