Hi All- I’m a little confused; there is not an LOS that states, “calculate loss given default/PV expected loss”, however CFAI text goes into detail about calculating. There are some holes in the equations that prevent me from thoroughly grasping (I.E. the N(-d1) components).
The end of chapter questions focus on this but do not require you to calculate the values; you’re simply subtracting the valuation amount from PV risky vs PV risk free. Has anyone noticed this as well?
Thanks!
Bheuler…??
Can you point to specifc pages or questions? Having trouble following exactly what you’re asking here.
Appreciate the response; apologies on the vagueness, this was written near the end of yesterday’s caffeine induced study session.
Referring specifically to page 267 in the CFAI text- example 4. Having a difficult time understanding/reconciling the value for N(-d1), N(-d2), N(-e1), and N(-e2). Similarly page 275 example 5 is the same concept but for reduced form models. This seems much more logical, which I do understand.
The LOS states to “understand the models and PV of expected loss” but the end of chapter questions are much more simple. Thanks again.
Just saw your question and I second it. I felt confised as well and turned to John Hull’s Options and Futures and spent time on chapters 11, 12, and 13 (they are fairly small and intuitive) as a foundation for Black Scholes f-la that will be needed anyway in Derivative Reading.
PLUS you get a good grasp of risk-neutral probabilities which are not really probabilities per ce but are WEIGHTS in the derived math formula. The probability interpetation is given to them by the author which is reasonable but there is nothing probabilistic about their derivation. Use of risk free rate vs required return on equity also becomes clearer.
I also second that there is no way to understand how they arrive at loss given default f-la in structured model among other math details. I just thought that diving into Hull’s textbook is a reasonable thing to do in view of upcoming derivative’s material.
The chances of being tested on calculation is less probable, however understanding the concept is critical. for example, I think you are referring to when questions being asked about calculating credit spread? Is that correct? In that PV of expected loss is needed to determine credit spread but in all the questions I came across those values were given.
I feel that these 3 concepts are very important from exam perspective:
Loss given default
Expected Loss
PV of Expected Loss
The following 2 LOS in CFA Level 2 curriculum for June 2017 exam uses above mentioned terms. The keyword in LOS 38.a is " Explain" which require understanding of the concepts.
The keyword in LOS 38.h is " Explain" and " Interpret" which require understanding of how you calculate and interpret the 3 concepts mentioned above.
LOS 38.a is Explain probability of default, loss given default, expected loss, and present value of the expected loss and describe the relative importance of each across the credit spectrum.
LOS 38.h is Calculate and interpret the present value of the expected loss on a bond over a given time horizon.