Credit Risk Management Edinburgh Business School

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This course text is part of the learning content for this Edinburgh Business School course . In addition to this printed course text you should have access to the course website in this subject . which will provide you with more learning content the Profiler software and past examination questions. and answers , The content of this course text is updated from time to time and all changes are reflected in the version. of the text that appears on the accompanying website at http coursewebsites ebsglobal net . Most updates are minor and examination questions will avoid any new or significantly altered material for. two years following publication of the relevant material on the website . You can check the version of the course text by referring to the version release number on the front. page of the text and comparing this to the version number of the latest PDF version of the text on the. website , If you are studying this course as part of a tutored programme you should contact your centre for. further information on any changes , Full terms and conditions that apply to students on any of the Edinburgh Business School courses are. available on the website www ebsglobal net and should have been notified to you either by Edinburgh. Business School or by the centre or regional partner through which you purchased your course If this is. not the case please contact Edinburgh Business School at the address below . Edinburgh Business School,Heriot Watt University,Edinburgh. EH14 4AS,United Kingdom,Tel 44 0 131 451 3090,Fax 44 0 131 451 3002.
Email enquiries ebs hw ac uk,Website www ebsglobal net. The courses are updated on a regular basis to take account of errors omissions and recent. developments If you d like to suggest a change to this course please contact. us comments ebs hw ac uk , Credit Risk Management,Ken Brown MA MSc. Ken Brown MA Econ Hons MSc International Banking and Financial Studies is a Finance lecturer in. EBS having previously worked as a Finance lecturer in the Department of Accountancy and Finance at. Heriot Watt University His main area of interest is mergers and acquisitions and he has contributed to. publications on acquisitions ,Dr Peter Moles MA MBA PhD. Peter Moles is on the faculty of the University of Edinburgh Business School He took up this post. following a career in the City in the international capital markets working for a number of banks latterly. for Chase Investment Bank His responsibilities included the consultative selling of financial products . customer related roles in product management origination trading and corporate advisory His last. major post at Chase was as eurobond syndicate manager His main research interests are in risk man . agement principally financial risk management including foreign exchange management problems and the. management of financial distress He has an interest in how management decisions are made and the. issues associated with managing complex problems Training assignments have included KPMG pro . gramme WM Company NatWest Markets the Advanced Management Programme in Scotland AMPS . and Capital Markets training for PBG Bank Lodz Poland . He is the principal author of the Handbook of International Financial Terms and has written two textbooks . Financial Risk Management and Derivatives He also wrote the financial evaluation modules for the Mergers. and Acquisitions course He is currently engaged in editing an encyclopaedia of financial engineering and. risk management , First published in Great Britain in 2008 . Ken Brown Peter Moles 2008 2011 2014 , The rights of Ken Brown and Peter Moles to be identified as Authors of this Work have been asserted in.
accordance with the Copyright Designs and Patents Act 1988 . All rights reserved no part of this publication may be reproduced stored in a retrieval system or. transmitted in any form or by any means electronic mechanical photocopying recording or otherwise. without the prior written permission of the Publishers This book may not be lent resold hired out or. otherwise disposed of by way of trade in any form of binding or cover other than that in which it is. published without the prior consent of the Publishers . Contents,Preface ix, Format of the Course ix, Spreadsheets x. Assessment xi, PART 1 INTRODUCTION TO CREDIT RISK MANAGEMENT PROCESS AND. TECHNIQUES,Module 1 Introduction 1 1, 1 1 Introduction 1 2. 1 2 Credit Assessment Methods 1 11, 1 3 Expected Losses and Unexpected Losses 1 20. 1 4 Controlling Credit Risk 1 25, 1 5 The Credit Policy Manual 1 33.
Learning Summary 1 37, Review Questions 1 39, Case Study 1 1 Determining the Credit Risk of a Portfolio 1 43. PART 2 UNDERSTANDING AND EVALUATING FINANCIAL STATEMENTS. Module 2 Understanding Financial Statements 2 1, 2 1 Introduction 2 2. 2 2 Double Entry System 2 6, 2 3 Reported Financial Statements 2 18. 2 4 Problems with Financial Statements 2 33, Learning Summary 2 49. Review Questions 2 53, Case Study 2 1 XYZ Company Part I 2 61.
Module 3 Ratio Analysis 3 1, 3 1 Introduction 3 2, 3 2 Ratio Analysis 3 5. 3 3 Using Ratios 3 20, 3 4 Analytic Relationship Models 3 23. Learning Summary 3 27, Review Questions 3 30, Case Study 3 1 XYZ Company Part II 3 33. Credit Risk Management Edinburgh Business School v. Contents, PART 3 QUALITATIVE AND QUANTITATIVE METHODS FOR EVALUATING. CREDIT RISK BASED ON BORROWER INFORMATION,Module 4 Expert and Rating Systems 4 1 .
4 1 Introduction 4 2, 4 2 Credit Evaluation 4 4, 4 3 Qualitative Credit Assessment Processes 4 5. 4 4 Credit Ranking 4 9, 4 5 Behavioural Ranking 4 21. Learning Summary 4 25, Appendix 4 1 Standard Poor s Long Term Issue Credit Ratings 4 27. Appendix 4 2 Nationally Recognised Statistical Rating Organisation NRSRO 4 29. Review Questions 4 30, Case Study 4 1 Credit Report on Abercrombie Services plc 4 33. Module 5 Credit Scoring and Modelling Default 5 1 . 5 1 Introduction 5 2, 5 2 Statistical Basis for Modelling Credit 5 6.
5 3 Applying Scoring Models to Firms 5 25, 5 4 Consumer Credit Scoring 5 30. 5 5 Behavioural Scoring Models 5 37, 5 6 Advantages and Limitations of Credit Appraisal and Default. Prediction Methods 5 40, Learning Summary 5 44, Review Questions 5 48. Case Study 5 1 XYZ Company Part III 5 52, Case Study 5 2 Developing a Corporate Scorecard 5 53. PART 4 MARKET BASED CREDIT EVALUATION METHODS,Module 6 Market Based Credit Models 6 1 .
6 1 Introduction 6 2, 6 2 Credit Risk Portfolio Model 6 17. 6 3 The Economic Factors Model CreditPortfolioView 6 47. Learning Summary 6 52, Review Questions 6 54, Case Study 6 1 Portfolio Credit Value at Risk 6 62. vi Edinburgh Business School Credit Risk Management. Contents,Module 7 Market Default Models 7 1, 7 1 Introduction 7 2. 7 2 Debt and the Option to Default 7 6, 7 3 The Insurance Approach CreditRisk 7 27. 7 4 The Differences between the Models 7 41, 7 5 Credit Derivatives 7 43.
Learning Summary 7 45, Appendix 7 1 Normal Distribution Tables for Black Scholes Merton Option. Pricing Model 7 49, Appendix 7 2 Poisson Distribution Tables for Insurance Model 7 51. Review Questions 7 53, Case Study 7 1 Valuing the Default Put 7 58. PART 5 MANAGING CREDIT RISK BY INDUSTRIAL AND COMMERCIAL FIRMS. Module 8 Managing Credit Risk in a Corporate Environment 8 1. 8 1 Introduction 8 2, 8 2 Credit Administration 8 3. 8 3 Determining a Line of Credit 8 5, 8 4 Evaluating Changes in Credit Policy 8 11.
8 5 Monitoring and Collections 8 21, 8 6 Collection Procedures 8 31. 8 7 International Credit Risk Management 8 33, Learning Summary 8 40. Review Questions 8 43, Case Study 8 1 Analysing a Change in Trade Credit Policy 8 48. PART 6 DEALING WITH POST LENDING PROBLEMS,Module 9 Financial Distress 9 1. 9 1 Introduction 9 2, 9 2 Capital Structure 9 5, 9 3 Capital Structure and Financial Distress 9 13.
9 4 Agency Costs in Financial Distress 9 21, 9 5 Causes of Financial Distress 9 26. 9 6 Costs of Financial Distress 9 32, Learning Summary 9 37. Review Questions 9 39, Case Study 9 1 Financial Distress at Norne 9 42. Credit Risk Management Edinburgh Business School vii. Contents,Module 10 Bankruptcy 10 1 , 10 1 Introduction 10 2. 10 2 The Bankruptcy Framework 10 4, 10 3 The Bankruptcy Process 10 7.
10 4 Chapter 11 Bankruptcy 10 17, 10 5 Pre packaged Bankruptcy 10 27. 10 6 Valuation in Bankruptcy 10 30, 10 7 International Comparisons 10 35. Learning Summary 10 40, Review Questions 10 43, Case Study 10 1 Honey Clothing s Choices in Reorganisation 10 45. Appendix 1 Practice Final Examinations and Solutions A1 1. Examination One 1 2, Examination Two 1 11, Appendix 2 Formula Sheet for Credit Risk Management A2 1. 1 Ratio Analysis 2 1, 2 DuPont Model 2 3, 3 Credit Scoring and Modelling Default 2 3.
4 Market Based Credit Models 2 4, 5 Managing Credit Risk in a Corporate Environment 2 7. Appendix 3 Answers to Review Questions A3 1, Module 1 3 1. Module 2 3 8, Module 3 3 13, Module 4 3 17, Module 5 3 20. Module 6 3 26, Module 7 3 38, Module 8 3 43, Module 9 3 48. Module 10 3 54,Index I 1, viii Edinburgh Business School Credit Risk Management.
Preface, The worldwide credit crunch which started in 2006 with sub prime mortgages in. the United States has highlighted the fundamental importance of the credit deci . sion As the problems in these mortgages unfolded it was demonstrated that. unsound credit decisions had been made and lessons as to how to manage credit. risk effectively had been either ignored or never learned This shows that poor. lending decisions whether by a financial institution or a corporate can lead to. significant losses What the incredible losses sustained by banks and others caught. up in the credit crunch have underlined is the major impact of credit risk and by. implication credit risk management on the wellbeing and profitability of business . es Being able to manage this risk is a key requirement for any lending decision This. is well understood in theory if not always in practice by banks and other lending. institutions that make their profit by advancing money to individual and corporate. borrowers It should also be well understood by industrial and commercial firms. that in the course of their normal business provide trade credit . While the credit decision is relatively straightforward in principle a lender must. decide whether to give credit or refuse credit to a potential client in practice it. involves experience judgement and a range of analytic and evaluative techniques. that are designed to determine the likelihood that money will be repaid or equally . that the money will be lost by the credit not being able to repay . This course covers the essential credit assessment processes that involve credit. risk identification evaluation and subsequent management It largely adopts a. process and techniques based approach to credit risk assessment that covers a. range of judgemental or experience based methods and more formal or analytical. models that have been developed to support the ultimate decision The course also. covers how credit losses may be mitigated once they have been incurred and money. recovered if a credit defaults on its obligation . Format of the Course, The 10 modules that make up Credit Risk Management can be broken down into six. parts as given below , Part Topic Areas Modules, 1 Introduction to credit risk management process and techniques 1. 2 Understanding and evaluating financial statements 2 and 3. 3 Qualitative and quantitative methods for evaluating credit risk 4 and 5. based on borrower information, 4 Market based credit evaluation methods 6 and 7. 5 Managing credit risk by industrial and commercial firms 8. 6 Dealing with post lending problems 9 and 10, Credit Risk Management Edinburgh Business School ix.
Preface, Part 1 sets out the key elements that cover the credit evaluation process This. takes a decision theory approach to highlight the logical way in which credit can be. assessed It introduces the techniques that are expanded upon in later modules and. considers how the process may be documented , Part 2 explores the way financial statements are constructed some of the issues. in the way they are presented and how this key information about the status of. potential and actual credits can be used to help determine the standing of an entity . Accounting data is very important in assessing the credit standing of businesses and. can be considered the foundation for all such evaluations . This is then followed by two modules Part 3 that examine how corporate and. personal information can be used both in a qualitative way and in more formal . mathematical models to analyse credit risks for firms and individuals Many tech . niques use templates and rules of thumb but increasingly models that make use of. large quantities of information about groups of credits are used to compare and. evaluate expected credit behaviour These are the so called scoring models which . like the judgemental approaches seek to compare a new credit applicant to known. credits An attraction of formal models is the way they systemise how a c. Credit Risk Management Edinburgh Business School ix Preface The worldwide credit crunch which started in 2006 with sub prime mortgages in the United States has highlighted the fundamental importance of the credit deci sion As the problems in these mortgages unfolded it was demonstrated that

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