Macroeconomic Analysis of The Hyperinflation Second Great Depression

Credit Derivative Practices and Principles


Paraphrased from: Derivatives: Practices and Principles A nine question CDS quiz -- Failed by the credit-derivatives geniuses!

  1. Did Senior Management perform overall risk management and capital policies approved by their boards of directors? Did dealers or end-users allow independent market risk management functions, at the board level or near-board level to assist senior management in establishing consistent policies and procedures applicable to various activities?
  2. Did dealers or end-users mark their derivatives positions to market, on at least a daily basis, for risk management purposes? If dealers did mark their derivatives positions to market, did they use mid-market valuation adjustments that allow for expected future costs such as unearned credit spread, close-out costs, investing and funding costs, and administrative costs?
  3. Did dealers or end-users identify and isolate individual sources of revenue for their derivatives positions to develop a more refined understanding of the risks and returns of derivative activities?
  4. Did dealers or end-users use a consistent measure to calculate daily market risk of their derivatives positions and compare it to market risk limits? For example, did dealers use industry standard probability analysis based upon a common confidence interval (e.g., two standard deviations) and time horizon (e.g., a one-day exposure)? More specifically, did dealers use components of market risk that should be considered across the term structure to include absolute price or rate change (delta); convexity (gamma); volatility (vega); time decay (theta); basis or correlation; and discount rate (rho)?
  5. Did dealers or end-users perform periodic simulations to determine how their portfolios would perform under stress (black swan) conditions? Did they ensure that these stress simulations of improbable market events test assumptions, valid for normal markets, that may no longer hold true in abnormal markets?
  6. Did dealers or end-users perform investing and funding forecasts which reveal cash investing and funding requirements arising from their derivatives portfolios? Where the dealers able to forecast surpluses and funding needs, by currency, over time? And did the dealers examine the potential impact of contractual unwind provisions or other credit provisions that produce cash or collateral receipts or payments?
  7. Did dealers and end-users measure credit exposure on the replacement cost of derivatives transactions, that is, their market value? And did they estimate of the future replacement cost of derivatives transactions?
  8. Did dealers and end-users aggregate net credit exposure to a given counterparty? To limit credit exposure, were there master agreements signed with the counterparty to document existing and future derivatives transactions, including foreign exchange forwards and options?
  9. Did dealer and end-user employ credit management where credit downgrades would trigger early termination or collateral requirements and did the dealer and end-user consider their capacity, and that of their counterparties, to meet potentially substantial funding needs that might result from a credit downgrade?