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CRMM-12-mitigating-counterparty-credit-risk.html
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<!doctype html>
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<title>Credit Risk Measurement and Management | Chapter 12 | Mitigating Counterparty Credit Risk</title>
<meta name="description" content="Financial Risk Manager Part 2 Study Materials">
<meta name="author" content="MacLane Wilkison">
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<section>
<h1>Chapter 12</h1>
<h3>Mitigating Counterparty Credit Risk</h3>
<p>
<small>Created for <a href="http://alchemistsacademy.com">Alchemists Academy</a> by <a href="http://alchemistsacademy.com/about">MacLane Wilkison</a></small>
</p>
</section>
<section>
<h2>Introduction</h2>
<ul>
<li>Default-remote entities - entities with a low probability of default</li>
<li>Termination events - opportunity to terminate a transaction between inception and maturity</li>
<li>Netting - offsetting transactions when a counterparty is in default</li>
<li>Close-out - termination of all contracts between an insolvent and solvent counterparty</li>
<li>Collateralization - posting cash or securities as a guarantee against exposure</li>
</ul>
</section>
<section>
<h2>Default-Remote Entities</h2>
<ul>
<li>High-quality counterparties</li>
<li>Special purpose vehicles</li>
<li>Central counterparties</li>
</ul>
</section>
<section>
<h2>Termination and Walkaway Features</h2>
<ul>
<li>Termination events - break clauses, ratings triggers, mergers, management changes, NAV declines, key person events</li>
<li>Walkaway clause - allows a surviving institution to walk away from net liabilities to a counterparty in default</li>
</ul>
<aside class="notes">
A break clause gives the holder the right to terminate a contract.
</aside>
</section>
<section>
<h2>Netting and Close-Out</h2>
<ul>
<li>Netting - the right to offset amounts due at termination of separate contracts between the same counterparties</li>
<li>Close-out - the right to terminate contracts unilaterally under certain conditions</li>
</ul>
</section>
<section>
<h2>Collateral</h2>
<img src="images/CRMM12/collateralization-illustration.png" alt="illustration of collateralization" />
</section>
<section>
<h2>Collateralization Specifications</h2>
<ul>
<li>Linkage of collateral parameters to credit quality</li>
<li>Frequency of margin calls</li>
<li>Threshold - a level of exposure below which collateral will not be called</li>
<li>Initial margin - collateral that is posted upfront</li>
<li>Minimum transfer amount - smallest amount of collateral that can be transferred</li>
<li>Rounding - collateral calls will be round up or down to certain lot sizes</li>
<li>Haircuts - a discount applied to the value of collateral</li>
<li>Coupons and interest payments</li>
<li>Substitution and rehypothecation</li>
</ul>
</section>
<section>
<h1>THE END</h1>
<h3><a href="http://alchemistsacademy.com">AlchemistsAcademy.com</a></h3>
</section>
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