Gregory Chapter 4

[wanderer87]

Hi David,

I was going through the material (Gregory) on page 52 , can you please explain as to how does the exposure increase in case of bonds when the interest rates decline?

 

[David Harper CFA FRM]

Hi @wanderer87 Gregory says the exposure "may increase." It is simply due to the fact that a long bond position increases in value when rates decline. The exposure plot for a bond is initially flat (at 100%) but the y-axis is potential future exposure (PFE) so it is function of future mark-to-market value; i.e., exposure is firstly a market risk. It can be flat at 100% of an increasing exposure (a positive MtM value).

For example, say the risky discount rate is 4% such that you loan me = -PV(4%, 10, 100,0) = $811.09 in exchange for my promise to repay with 10 installments of $100 each year over the next ten years. Immediately, as the positive mark-to-market value is $811.09, this is your credit exposure; my credit exposure is zero because my MtM is negative and exposure = Max(0, MtM). Now imagine that the rate decreases to 3%: this implies a MtM gain to = -PV(3%, 10, 100,0) = $853.02. Your credit exposure (your loss if I, the counterparty, defaults) increases. I hope that helps,

 

[Stenmaster]

Hi David!

Do you have any corresponding Videos for Chapters 3, 5, 8, 10 and 12?

Let me know

 

[Nicole Seaman]

Hello @Stenmaster,

Thank you for using Bionic Turtle! We do not currently have videos to correspond with those chapters, however, when a new video is published you will see a "New" symbol in the study planner next to that specific video. Please keep in mind that at any given point in time, some readings will not be covered by notes, practice questions and/or videos. During the second semester of the year (i.e., between May and November), we continue to add to our material, depending on perceived priority.

Thank you,

Nicole

 

[Stenmaster]

Thanks!