Download Central Bank of Egypt Credit Risk

Central Bank of Egypt
Financial Risk Management
Central Bank of Egypt
Types of risks
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Central Bank of Egypt
Credit Risk
• Risk that the issuer will not make scheduled payments. The
higher the risk of negative credit event (default, etc), the
higher the interest rate investors will demand for assuming
that risk.
• •Private rating agencies (Moody’s and Standard & Poor’s)
provide guidance for investors to the credit quality of
various issues.
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Central Bank of Egypt
Credit Risk
• Short Term: It is the relative credit risk of obligations with
an original maturity not exceeding thirteen months.
• Long Term: It is the relative credit risk of obligations with
anoriginal maturity of more than one year (in practice about
3 years horizon)
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Central Bank of Egypt
Credit risk
Credit spread = difference between the yields on a “default
able” corporate bonds and a US government bond of
comparable maturity.
• Spreads between interest rates on various private and public
sector debt contain valuable information
• Spreads widen during recession and contract during
economic expansion
• Contracting spreads is a positive sign for markets/economy
• Looking for default risk changes and liquidity changes in
the market
• Different ways to compare short-term vs. long-term interest
rate/inflation expectations
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Central Bank of Egypt
Credit risk
Credit Default Swaps:
A huge market with over $40 trillion of notional principal
Buyer of the instrument acquires protection from the seller
against a default by a particular company or country (the
reference entity)
Example: Buyer pays a premium of 90 bps per year for $100
million of 5-year protection against company X
Premium is known as the credit default spread. It is paid for
life of contract or until default
If there is a default, the buyer has the right to sell bonds with a
face value of $100 million issued by company X for $100
million (Several bonds are typically deliverable)
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Central Bank of Egypt
Credit risk
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Central Bank of Egypt
Credit risk
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Central Bank of Egypt
Liquidity risk
• Liquidity risk is concerned with an investor having to sell a
bond below its indicated value, the indication having come
from a recent transaction.
• Liquidity refers to how deep or liquid the market is for a
particular security. If the market is deep, an investor can
purchase or sell a security at current prices. If the market is
not liquid, it is harder to sell or buy a security at the last
market price.
• Liquidity is typically measured by the bid/ask spread. If the
spread is wide, the market is illiquid. If the spread is
narrow, the market is more liquid.
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Central Bank of Egypt
Liquidity risk
• Liquidity risk is important because it tells you how easily
you can get rid of a position if you need to close it near the
last market price.
• This is even more important if you plan to hold a security to
maturity because of the marking to market of your
positions. In an illiquid market, it may be hard to obtain
quotes, and when you revalue the security it could be well
below market prices, affecting the reports you send to
clients and management.
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Central Bank of Egypt
Currency risk
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Central Bank of Egypt
Currency risk
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Central Bank of Egypt
Currency risk
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Central Bank of Egypt
Currency risk
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Central Bank of Egypt
Other risks
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Central Bank of Egypt
Other risks
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Central Bank of Egypt
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