Market Risk vs Credit Risk - Sandeep Kanao

Market RiskPotential loss in market value of our position if a market risk factor goes against our position.  VaR is the common measure used

Credit Risk
Credit Risk = Exposure x Credit Worthiness x Severity

Exposure
Potential loss as a result of counterparty default

Credit Worthiness
Probability of default or credit migration

Severity
Fraction loss give default
Severity = 1 – Recovery Rate

Methods for Measuring Counterparty Exposure - Sandeep Kanao

Portfolio Simulation MethodSimulate multiple scenarios of future values of risk factors. E.g. FX rates, Interest Rates, Commodity and Equity prices…
Value each deal in the portfolio using simulated market risk factors as input to pricing models
Aggregate counterparty exposure using appropriate netting rules, margin and collaterals agreements
Calculate the exposure measures
Confidence level exposure (e.g. 95%)
Expected Exposure and Effective Exposure