1. The Public EDF Model Developed by: The Market Information Lab Fall 2009 CreditEdge Tutorial

2. Credit Risk in Financial Markets Limitless Opportunities Dynamic Credit Environment Numerous Market Sectors Complexity of Financial Statements Bottom Line: How likely is it that we get paid back?

3. Tutorial Overview CreditEdge Overview What/Who/How for CreditEdge Calculating Expected Default Frequency (EDF) Calculating the Three Drivers The CreditEdge Interface Building and Portfolio Analyzing a Company Graphically Estimation Using Scenario Analysis

4. Structure of the Products Moody’s Credit Rating Agency Moody’s KMV CreditEdgeRiskCalc MIL Product Public Co. Credit RiskPrivate Co. Credit Risk Subsidiary

5. What is CreditEdge? Product developed by Moody’s CompanyProduct developed by Moody’s Company Calculation of Public Company DefaultCalculation of Public Company Default Likelihood of Lender Getting Paid BackLikelihood of Lender Getting Paid Back Unbiased Comparison of Public CompaniesUnbiased Comparison of Public Companies

6. Who Uses CreditEdge? LendersLenders Access counterparty riskAccess counterparty risk Determines likelihood of getting paid backDetermines likelihood of getting paid back i.e. Barclaysi.e. Barclays Large CorporationsLarge Corporations Analysis of Internal Credit RiskAnalysis of Internal Credit Risk Gauge of competitor credit statusGauge of competitor credit status i.e. Hewlett-Packardi.e. Hewlett-Packard Fixed Income Investors/AnalystsFixed Income Investors/Analysts

7. How CreditEdge Works Public Company Probability of Default Internal Company Data / External Market Conditions Portfolio Management with many companies

8. Check Your Understanding Question: Which of these financial analysts would NOT benefit from CreditEdge? A. Fixed Income Analysts B. Credit Risk Lenders C. Internal Corporate Financial Analyst D. Equity Analysts E. All of the Above Can Benefit CreditEdge

9. Expected Default Frequency Definition – The Probability that a company’s value will fall below a threshold where its unable to pay back its creditors Three EDF Drivers for calculation: Default Point Market Value of Assets Asset Volatility Case Application: General Electric (GE)

10. Calculation of EDF EDF = Market Value of Assets Default Point X Asset Volatility Formula:

11. Default Point Defined – A threshold where the company’s value is not sufficient to payback what it owes Between Total Liabilities and ST Liabilities Empirical Studies Reveal Accurate Formula Default Point = ST Liabilities + ½ (LT Liabilities)

12. GE Default Point Total Liabilities - ST Liabilities __________________ LT Liabilities Default Point ST Liabilities + (1/2) LT Liabilities DEFAULT POINT 246,133,000 + (1/2) 433,675,000 679,788,000 - 246,113,000 433,675,000 462,970,500 Source: Capital IQ Note: Numbers are in Thousands

13. Market Value of Assets Market Capitalization of Assets Book Value of Liabilities: Senior Claims Market Capitalization of Equity: Junior Claims Formula: MV Assets = Market Cap. + BV Liabilities

14. GE Market Value of Assets Market Cap. + BV Liabilities __________________ Market Value of Assets 118,940,000 + 679,778,000 798,728,000 Source: Capital IQ

15. Check Your Understanding Question: Warren Buffet decides to purchase $50 billion in Senior Unsecured Corporate Bonds from GE. What will happen to GE’s EDF A. It will remain the same B. It will increase because of the increase to GE’s Default Point C. It will decrease because of the increase to GE’s Market Value of Assets D. It will increase because the increase to MV of Assets will not have as great of an effect as the Default Point increase. EDF = Market Value of Assets Default Point X Asset Volatility

16. Calculating New Default Point

17. Calculating New MV of Assets

18. Putting it All Together The Ratio Decreased, what does that mean? Numbers in Billions Debt Raised 50 Category of Capital LIABILITY/DEBT Assumption: Asset Volatility Remains Constant New Ratio: Default Point ÷ MV of Assets Old Ratio: Default Point ÷ MV of Assets Default Point 488 Default Point 463 Market Value of Assets 848 Market Value of Assets799 New Ratio 0.575472 Old Ratio 0.579474

19. Check Your Understanding Question: Warren Buffet decides to purchase $50 billion in Senior Secured Corporate Bonds from GE. What will happen to GE’s EDF? A. It will remain the same B. It will increase because of the increase to GE’s Default Point C. It will decrease because of the increase to GE’s Market Value of Assets D. It will decrease because the increase to MV of Assets will have a greater effect as the Default Point increase. EDF = Market Value of Assets Default Point X Asset Volatility

20. Uncertainty (Volatility) of a Firm High Volatility = Greater Probability Of Default Equity Return v. Asset Return Formula: Asset Volatility = Standard Deviation of MV of Assets Asset Volatility

21. GE Asset Volatility Standard Deviation Formula  Apply to Stock Market X-Bar = Expected Return X = Actual Return N = Number of Observations GE Share Price How do we get Asset Volatility? Where’s our Book Value of Liabilities?

22. GE Asset Volatility GE Asset Volatility = 0.88%

23. Check Your Understanding Question: An decrease in GE’s asset volatility will: A. Will have no effect on EDF B. Cause EDF to Increase C. Cause EDF to Decrease D. Asset Volatility has nothing to do with EDF EDF = Market Value of Assets Default Point X Asset Volatility

24. GE EDF Calculation EDF = Market Value of Assets Default Point X Asset Volatility Formula: EDF = 433,351,500 798,728,000 X 0.88% EDF = 0.477446 %... What does it mean?

25. Distance to Default Distance to Default = $ 365,373,500 How likely will it be for MV Assets to fall below Default Point? Distance to Default Distance to Default = Market Value of Assets – Default Point

26. Graphical Interpretation of EDF Asset Volatility = 0.88% EDF = 0.477% = Chance GE will Default in 1 Year EDF = Probability that Asset Value will fall below the Default Point

27. Check Your Understanding Question: What is the conceptual definition of a 1 Year EDF? A. It’s the probability that a firm will pay back its creditors in a year’s time. B. It’s the probability that a firm will not be able to pay back its creditors in a year’s time. C. It’s the number of standard deviations a firm is away from its default point. D. It’s the expected return on a firm’s stock. E. None of the Above

28. The CreditEdge Interface Portfolio creation and management Portfolio creation and management Company Analysis Company Analysis Charting Tool Charting Tool Solver and calculator scenario analysis Solver and calculator scenario analysis

29. Creation and Analysis of a Portfolio Create a Portfolio Adding companies to portfolio Analysis by EDF and credit rating Average EDF across portfolio Adjusting the time period

30. Individual Company Credit Analysis Sample Company – General Motors EDF highlights and ratings Current v. previous EDF Base Company Profile Company news and key developments Company SEC filings

31. Chart Building Sample Chart – EDF only How EDF calculation points factor in GM Comparison to Toyota

32. Check Your Understanding Question: What are the tasks you can't do with the Chart tool? A. Export as an Excel B. Chart Portfolio items C. Custom time series D. We can do all the above E. None of the Above

33. Scenario Analysis with Solver Solver overview and definition Sample Analysis – Volkswagen Sample Analysis – GM Calculator feature

34. Check Your Understanding Question: Holding everything else constant, if the MV of assets increases, what happens to GE’s EDF? A. Increases B. Decreases C. Stays the Same EDF = Market Value of Assets Default Point X Asset Volatility

35. Wrap-Up and Conclusion Other Moody’s KMV tutorials RiskCalc Tutorial MKMV Integration with Capital IQ MKMV Integration with Crystal Ball Words of wisdom on tool learning Questions and support