Credit risk

Credit risk refers to the possibility that a borrower or counterparty will fail to meet their obligations in accordance with agreed terms, which often results in a financial loss for the lender or investor. This risk is particularly relevant in the context of loans, bonds, and other financial instruments where the repayment of principal and interest depends on the creditworthiness of the borrower.

Credit rating agencies (CRAs) are organizations that assess the creditworthiness of entities, including governments, corporations, and financial instruments. They provide ratings that indicate the likelihood of a borrower defaulting on their debt obligations. These ratings help investors make informed decisions about the risks associated with lending money or making investments.

Credit scoring is a statistical method used by lenders to assess the creditworthiness of potential borrowers. It involves the calculation of a numerical score that reflects the credit risk of a borrower based on their credit history and financial behavior. Key components of credit scoring typically include: 1. **Credit History**: This includes an individual's past borrowing and repayment behavior, including the amount of debt, payment history, and the types of credit used.

"Advanced IRB" typically refers to advanced practices and methodologies used by Institutional Review Boards (IRBs) to review and oversee research involving human subjects. An IRB is a committee that is established to review research proposals to ensure that the rights and welfare of participants are protected.

The Altman Z-score is a financial metric used to assess a company's credit risk, specifically its likelihood of bankruptcy within a two-year period. Developed by Edward I. Altman in 1968, the Z-score combines five financial ratios that use information from a company's balance sheet and income statement.

A bond credit rating is an assessment of the creditworthiness of a bond issuer, which can include corporations, municipalities, or governments. This rating indicates the likelihood that the issuer will be able to meet its financial obligations, specifically the timely payment of interest and principal to bondholders. Credit rating agencies, such as Moody's, Standard & Poor's (S&P), and Fitch, assign these ratings based on various factors including the issuer's financial health, the economic environment, and overall market conditions.

The Chan–Karolyi–Longstaff–Sanders (CKLS) process is a popular class of affine term structure models used in finance to describe the evolution of interest rates. Specifically, it provides a framework for modeling the dynamics of interest rates over time, capturing their stochastic nature and allowing for the consideration of multiple factors that can affect rate movements. The CKLS model is characterized by a specific formulation of the stochastic differential equations governing the behavior of interest rates.

Concentration risk refers to the potential for significant losses that may occur as a result of an over-reliance on a single asset, group of assets, borrower, industry, geographic area, or any other category that comprises a substantial portion of an institution's holdings or revenue. This type of risk can manifest in various forms: 1. **Credit Concentration Risk**: This occurs when a lender or financial institution has a large exposure to a single borrower or a group of related borrowers.

A Constant Maturity Credit Default Swap (CMCDS) is a type of credit derivative that allows investors to manage exposure to credit risk while maintaining a constant average maturity in the swap's underlying reference obligation. Similar to standard credit default swaps (CDS), a CMCDS provides protection against credit events (like default or bankruptcy) of a specified reference entity, but it has unique characteristics relating to its maturity.

Consumer credit risk refers to the risk that a borrower will default on their loan obligations, failing to make required payments on time or at all. This risk is particularly relevant for lenders and financial institutions that offer credit products to consumers, such as personal loans, credit cards, mortgages, and auto loans.

A Contingent Convertible Bond (often abbreviated as CoCo bond) is a type of hybrid security that is designed to absorb losses and provide additional capital to a financial institution in times of financial distress. These bonds are primarily issued by banks and other financial institutions and are designed to convert into equity, typically common shares, under specific conditions.

A Credit-Linked Note (CLN) is a type of structured financial instrument that combines elements of debt and credit derivatives. It typically involves the following features: 1. **Debt Instrument**: At its core, a CLN is a debt security. Investors purchase it and receive interest payments, much like a traditional bond. 2. **Credit Risk**: The return of principal and interest payments is linked to the credit performance of a specified reference entity (often a corporation or a sovereign).

Credit analysis is the process of evaluating the creditworthiness of an individual, corporation, or financial instrument. The objective of credit analysis is to assess the risk associated with lending money or extending credit to a borrower. It involves examining various financial information, credit history, and other relevant data to make informed decisions about the likelihood of repayment.

The Credit Conversion Factor (CCF) is a key concept in the field of credit risk management and regulatory capital requirements for financial institutions. It is primarily used to convert off-balance-sheet exposures into equivalent on-balance-sheet credit exposures for the purposes of calculating capital requirements under frameworks like Basel III.

A Credit Default Option (CDO) is a type of financial derivative that provides protection against the risk of default on a specified debt instrument, such as a bond or a loan. It can be considered similar to a credit default swap (CDS), but with some distinct features.

A credit default swap (CDS) is a financial derivative that allows an investor to "swap" or transfer the credit risk of a borrower to another party. Essentially, it is a contract between two parties where one party (the buyer of the CDS) pays a periodic fee to the other party (the seller of the CDS) in exchange for protection against the risk of default on a specified debt obligation, such as a bond or loan.

A credit derivative is a financial instrument that allows one party to transfer credit risk to another party without transferring the underlying asset. Essentially, credit derivatives are used to manage exposure to credit risk—in particular, the risk that a borrower will default on a loan or bond. Here are the key aspects of credit derivatives: 1. **Purpose**: They are used primarily for risk management, allowing investors and financial institutions to hedge against potential defaults or to speculate on changes in credit risk.

A credit event is a specific occurrence that affects the creditworthiness of a borrower, typically leading to a default on a debt obligation. In the context of financial markets, credit events are especially important for credit derivatives, such as credit default swaps (CDS), where they trigger payouts or other actions from the protection seller to the protection buyer. Common examples of credit events include: 1. **Bankruptcy**: The borrower is unable to meet its liabilities and files for bankruptcy protection.

A credit reference is a statement or a report that provides information about an individual or a business's credit history and creditworthiness. It can be used by lenders, creditors, and other entities to assess how likely a borrower is to repay a loan or meet financial obligations. Credit references often include details such as: 1. **Credit Score**: A numerical representation of a person's creditworthiness based on their credit history.

In finance, "default" refers to the failure of a borrower to meet the legal obligations or conditions of a loan, which typically means that they are unable to make the scheduled payments of principal or interest. This can occur in various contexts, including: 1. **Corporate Default**: When a corporation is unable to pay its debts or interest on bonds it has issued. This could lead to bankruptcy or restructuring.

Expected loss is a concept used primarily in finance, risk management, and insurance to quantify the average loss that is anticipated over a specific time period due to various risks. It is calculated by multiplying the probability of an event occurring (such as default, loss, or damage) by the financial impact or loss associated with that event.

Exposure at Default (EAD) is a financial term commonly used in risk management and credit risk analysis. It refers to the total amount of money that a lender is exposed to at the time of a borrower's default on a loan or credit obligation. EAD is a critical component in the calculation of regulatory capital requirements for banks and financial institutions under frameworks such as Basel II and Basel III. EAD represents the potential loss that a lender may incur if a borrower fails to meet their repayment obligations.

FASB 133, formally known as Statement of Financial Accounting Standards No. 133, is a standard issued by the Financial Accounting Standards Board (FASB) in June 1998. The primary purpose of FASB 133 is to establish accounting and reporting standards for derivative instruments and hedging activities.

Foundation IRB (Institutional Review Board) is an organization that provides ethical review and oversight for research studies, particularly in the fields of healthcare and behavioral sciences. Foundation IRB helps researchers ensure that their studies comply with ethical standards and regulations, protecting the rights and welfare of human subjects involved in research.

High-yield debt, often referred to as "junk bonds," is a type of bond that carries a higher risk of default compared to investment-grade bonds. These bonds are issued by companies or entities that have lower credit ratings, typically rated below BBB- by Standard & Poor's or below Baa3 by Moody's. Because of the increased risk associated with high-yield debt, these bonds offer higher interest rates (or yields) to attract investors.

IAS 39, or International Accounting Standard 39, is an accounting standard that was issued by the International Accounting Standards Board (IASB) and deals with the recognition and measurement of financial instruments. The standard outlines the principles for Classifying, measuring, recognizing, and derecognizing financial assets and financial liabilities.

IFRS 9, or International Financial Reporting Standard 9, is a financial reporting standard established by the International Accounting Standards Board (IASB). It addresses the classification, measurement, and impairment of financial instruments, and it was issued in July 2014, replacing the earlier standard, IAS 39. ### Key Components of IFRS 9 1.

iTraxx is a brand of credit default swap (CDS) indices that are used to track the performance of a basket of credit derivatives, primarily in the European market. These indices offer investors a way to gain exposure to a diversified portfolio of credit risk, allowing them to hedge against defaults or speculate on credit spreads without having to trade individual credit default swaps.

Impairment in financial reporting refers to a permanent reduction in the value of an asset below its carrying amount on the balance sheet. When an asset is deemed impaired, it means that it can no longer generate sufficient future cash flows to justify its recorded value. Therefore, an impairment loss must be recognized in the financial statements to reflect this decrease in value.

The term "infection ratio" can refer to different concepts depending on the context in which it is used, particularly in healthcare and microbiology. However, it is not a standardized term, so its meaning might vary. Here are a few interpretations: 1. **Epidemiological Context**: In public health, the infection ratio could refer to the ratio of infected individuals to the total population at risk for a specific infectious disease within a certain time frame. This might be expressed as a percentage.

The Internal Ratings-Based (IRB) approach is a method used by banks and financial institutions to calculate the capital requirements for credit risk under regulatory frameworks, such as the Basel Accords. This approach allows banks to use their own internal estimates of credit risk parameters to determine the capital necessary to protect against potential losses from their lending activities.

The Jarrow–Turnbull model is a framework used in finance to assess the credit risk of a firm, specifically focusing on the pricing of defaultable bonds. Developed by Robert Jarrow and Stuart Turnbull in the early 1990s, the model is a structural model of credit risk that incorporates the notion that a firm's default occurs when its asset value falls below a certain threshold, typically a level of liabilities or a debt obligation.

A Loan Credit Default Swap Index (LCDX) is a financial instrument that represents a basket of credit default swaps (CDS) associated with a pool of corporate loans, typically those that are leveraged and below investment grade in quality. The index provides a way for investors to gain exposure to the credit risk of a diversified set of leveraged loans.

Loss Given Default (LGD) is a key financial metric used in credit risk management and is one of the components used to calculate expected credit losses in lending and investment. LGD represents the amount of loss a lender incurs when a borrower defaults on a loan, expressed as a percentage of the total exposure at the time of default.

In finance, "margin" refers to the amount of equity that an investor must hold in their account when borrowing funds from a broker to purchase securities, or it can refer to the difference between the cost of goods sold and the sales revenue.

Margin at Risk (MaR) is a risk management metric used in the context of trading and investments to quantify the potential loss that a trader could face based on the margin they have in their trading account. Essentially, it reflects how much of a trader's margin is at risk of being lost due to adverse price movements in the assets they are trading.

Margining risk, also known as collateral risk, refers to the potential financial risks associated with the margining process in financial transactions, particularly in derivatives and trading markets. Margining is the practice of requiring traders to post collateral (margin) to cover potential losses on their positions. This collateral is meant to protect against defaults and ensure that both parties fulfill their obligations.

The Merton model, developed by Robert C. Merton in 1974, is a structural model used to assess the credit risk of a company's debt. It is particularly known for its application in estimating the probability of default for corporate debt and in pricing corporate liabilities. The model is based on the idea that a company's equity can be viewed as a call option on its assets.

The Ohlson O-score is a financial metric developed by James Ohlson in 1980 to assess the likelihood of a company's bankruptcy. It is a part of a broader framework for predicting financial distress and is commonly used in credit analysis and risk assessment. The O-score is calculated using a logistic regression model that incorporates several financial ratios and accounting measures. The formula includes variables such as: 1. **Net Income**: Profits or losses over a specified period.

PAUG stands for "Pangu Alpha Unleashed Generation." It is a term often associated with AI models and technologies related to the development of artificial intelligence systems. However, the specifics of what PAUG entails can vary based on context, as it might refer to a particular framework, a research initiative, or a version of AI models designed for certain applications or tasks.

The Probability of Default (PD) is a financial term used to quantify the likelihood that a borrower will fail to meet their debt obligations within a specified time frame, such as one year. It is a critical metric in credit risk management, used by lenders, investors, and financial institutions to assess the creditworthiness of borrowers, including individuals, corporations, and governments.

A recovery swap is a financial instrument typically used in the context of restructuring debts or managing financial distress. While the term can have specific meanings in different contexts, it generally refers to an agreement between parties to exchange certain cash flows or assets with the aim of improving the financial position of one party, often in a distressed situation.

Redlining is a discriminatory practice that began in the United States in the 1930s, where banks and insurance companies would deny services, such as mortgages and insurance, to residents of certain neighborhoods based on racial or ethnic demographics rather than individual creditworthiness. The term "redlining" comes from the practice of using red ink to outline areas on maps that were deemed too risky for investment, often correlating with predominantly African American or minority communities.

Refinancing risk refers to the potential danger faced by borrowers when they need to refinance their existing debt, typically due to unfavorable loan conditions or market changes. This risk can materialize in several ways: 1. **Higher Interest Rates:** If market interest rates rise significantly when a borrower seeks to refinance, they may end up with a higher interest rate on the new loan than on their current loan, leading to increased monthly payments and overall costs.

Risk-weighted assets (RWAs) are a measure used in banking and financial regulation to assess the risk levels associated with a bank's assets. RWAs are calculated by assigning a risk weight to each asset based on its credit, market, and operational risk. The risk weights are determined by regulatory frameworks, such as the Basel III accord, which aims to ensure that banks maintain adequate capital reserves to cover potential losses.

Securitization is a financial process that involves pooling various types of contractual debts, such as mortgages, car loans, or credit card debt, and then selling them as consolidated financial instruments, typically in the form of bonds, to investors. This process transforms illiquid assets into securities that can be traded in the financial markets.

The Standardized Approach for Counterparty Credit Risk (SA-CCR) is a framework established by the Basel Committee on Banking Supervision (BCBS) to calculate the counterparty credit risk (CCR) exposure that banks face when engaging in derivative transactions. It is designed to provide a more risk-sensitive and standardized method for measuring and managing counterparty credit risk compared to previous models.

The Standardized Approach (SA) is a method used to calculate credit risk capital requirements under the Basel Accords, which are international banking regulations set by the Basel Committee on Banking Supervision (BCBS). The objective of the SA is to provide a framework that allows banks to measure their exposure to credit risk and determine the minimum capital they must hold to cover potential losses.

A swap spread is a financial term that refers to the difference between the fixed rate of a swap contract and the yield on a government bond of a similar maturity. It is commonly used in interest rate swaps, where one party exchanges a fixed interest payment for a floating interest payment, typically linked to an index like LIBOR or SOFR (Secured Overnight Financing Rate).

The Journal of Credit Risk is an academic and professional publication that focuses on research related to credit risk management and assessment. The journal publishes original research articles, reviews, and case studies that contribute to the understanding of credit risk, its measurement, modeling, and management practices. Topics might include credit risk modeling techniques, regulatory frameworks, default prediction, credit scoring, and the impact of economic conditions on credit risk.

A Total Return Swap (TRS) is a financial contract between two parties, typically referred to as the "payer" and the "receiver." In a TRS, one party (the total return payer) agrees to pay the total return of a specific asset (which can include capital appreciation, dividends, or interest) to the other party (the total return receiver) in exchange for a series of cash flows, usually as a fixed or floating interest rate.

Wrong way risk refers to the risk that a counterparty's credit quality deteriorates when exposure to that counterparty increases. In other words, it occurs in situations where the likelihood of a counterparty defaulting increases precisely when the exposure to that counterparty is at its highest. This creates a situation where the risk of loss is amplified because market conditions that adversely affect the counterparty's creditworthiness also elevate the value of the exposure.

XVA, or "X-Value Adjustments," is a collective term used in finance to refer to a group of risk adjustments made to the valuation of derivatives and other financial instruments. These adjustments account for various risks and costs that can affect the valuation and pricing of these instruments. The main components of XVA include: 1. **CVA (Credit Valuation Adjustment)**: This reflects the risk of counterparty default.

Yield spread refers to the difference in yields between two different financial instruments, typically bonds or other fixed-income securities. It is often expressed in basis points (bps), where one basis point is equal to 0.01%. The yield spread can provide insights into various market conditions and risk perceptions among investors. There are several contexts in which yield spreads are commonly discussed: 1. **Credit Spread**: This is the difference in yield between a corporate bond and a government bond (such as U.S.

The Z-spread, or zero-volatility spread, is a measure used in fixed income securities to provide insight into the relative value of a bond over the risk-free rate. It represents the constant yield spread that an investor would receive over the entire term structure of spot rates of a benchmark risk-free rate (often government treasury rates) if the bond's cash flows were discounted using these spot rates.