1. Structuring and Pricing Complex Credit Assets with Monte Carlo / @RISK 22.06.2006 – Jörg Günther

2. 2 EQUITY VS. CREDIT ASSETS Balance Sheet Assets Current Assests - - - Fixed Assets - - E&L Equity - - Debt - - Asset Markets Equity Stock-Price Debt Debt-Price; CDS Pricing- models Cash Flows CF from Operations CF from Investing CF from Financing (or: what is left for 1. Debt Service 2. Equity Distributions)

3. 3 EQUITY VS. CREDIT ASSETS - DERIVATIVES Equity Derivatives 1.Vanilla Options (Call/Put) 2.Complex Options (Barrier, Basket, Cliquet,...) Credit Derivatives 1.Credit Default Swaps (Credit Risk) 2.CDO-Tranches 3.other... Equity and Credit Assets – and their Derivatives - are structurally different, but are ultimately based on the same original Cash Flow of an Entity

4. 4 DIFFERENCES OF EQUITY AND CREDIT ASSETS Equity Assets liquid markets abundant empirical data on Underlyings Options Credit Assets Illiquid markets less empirical data, different focus (default/non-default) Sophisticated Market & Models Market & Models „work in progress“

5. 5 S&Ps RATING METHODOLOGY FOR CDO-TRANCHES Loss Distribution Monte-Carlo for Synthetic CDO- Structure PDs Recovery Rates Correlation Cash-Flow-CDO-Application Scenarios for Timing of default Interest rates Loss-Distribution used as input for cash-flow-model

6. 6 BASEL II – HOW MONTE CARLO HELPS TO COVER REGULATORY ISSUES Balance Sheet Bank E&L Equity Debt Assets Loans Basel II in % of loan risk-adjusted Standard non-specific, i.e. same or standardized risk-weight; on average more equiy to be provided IRB eg Project Finance: Based on Monte-Carlo More specific Rating; on average less equity

7. 7 PRICING A WIND POWER PROJECT-FINANCE-DEAL Cash Flow Model assumptions Sources / Uses Operating Cash Flow Financing Cash Flow Risk-Parameters Scenarios (what-if) Stochastic Assumptions Monte-Carlo Expected Loss Rating-Class Spread-sheet-example: Wind-Power-Project

8. 8 STRUCTURING A PORTFOLIO LOAN – THE CASH FLOW STRUCTURE Cash Flow of Underlyings Timing Assumptions Stochastic Assumptions Asset return Volatility Correlation Cash Flow of Financing Structure Order of financing and repayment/distributions defining loss / recovery rate Spread-sheet-example: PE-blind-pool

9. 9 STRUCTURING A PORTFOLIO LOAN – APPLYING MONTE- CARLO FOR THE PRICING Structuring Parameters Size of Equity-Tranche Order of Distributions (Cash-Flow-Waterfall) Interests Outputs of Analysis Expected Loss Return on Bank‘s Equity Return on Sponor‘s Equity Volatility / Risk of Returns Precise Pricing Precise Risk-Return- Packaging Spread-sheet-example: PE-blind-pool

10. 10 FUNCTIONS OF @RISK OFTEN USED Function Distributions Correlation Matrix Fit to Distribution D-Uniform-Distribution Issue / Questions involved Calculating Risk: Static -> Stochastic Analysis (Scenario -> Monte-Carlo) Quantifying Diversification: Portfolio-Structures Analyzing empirical data Bootstrapping