FRM Level 2 Formulas – Credit Risk Measurement and Management

Estimated reading time: 2 minutes

 

Introduction

We present the formulas for the Credit Risk Measurement and Management segment.

Note that this information may be downloaded this free of charge in PDF format.

Click here to visit our shop page.

 

Firm Value

[ Firm Value *  N ( d1 ) ]  –  [ Debt * e –rT  * N ( d2 ) ]

 

Netting Factor

Netting Factor = ( ( n + n*(n – 1)r )½  /  n

 

Expected Loss

Expected Loss = KN ( –e2 ) – At * e u ( T – t ) * N ( -e1 )

 

Debt Value

Value of Debt  =  Value of Risk Free Debt – Value of Put Option

St  =  Vt N * ( k + sv ( T – t ) ½ ) – K e –r(T – t)  * N ( k )

F’ ( t ) = l * e lt

F(u) =  1 – exp ( – hu )

Where:

h = ( Spread ) / ( 1 – Recovery )

 

Credit Spread

Credit Spread =  yD ( t,T ) – y P*( t,T ) =  lG

 

Conditional Prepayment Rate (CPR)

Conditional Prepayment Rate  =  1 – ( 1 –  Single Month Mortality Rate )12

CPR =  1 – ( 1 –  SMM )12

 

Credit Valuation Adjustment (CVA)

CVA   =  Loss Given Default  *  Exposure at Default  *  Default Probability

CVA  =  LGD * EAD * DP

CVA  =   ( 1 – Recovery Rate ) * S  [  ( Discount Factor ) * ( Exposure ) * ( Probability of Default ) ] 

 

Average Life

Average Life  = S [ ( t * Principal time t ) / ( 12 * Total Principal ) ]

CPR = 1 – ( 1 – SMM )12

 

Probability of Default

Default Probability = 1 – e lt

NB:

l  = Spread / ( 1 – Recovery Rate )

 

Default Correction

rab    = [ pab  –  (  pa  *  pb ) ]  /  [ pa * ( 1 –  pa ) ] ½  *  [ pb * ( 1 –  pb ) ] ½              

 

Exposure at Default (EAD)

EAD = Amount Drawn + ( Amount Limit – Amount Drawn ) * Loan Equivalent Ratio

 

Summary

We hope that this post was beneficial to you.

In addition, try the following links for even more information:

 

Success is near,

The QuestionBank Family