© Brammertz Consulting, 20091Date: Unified Financial Analysis Risk & Finance Lab Chapter 13: The going-concern view / General mechanisms Willi Brammertz / Ioannis Akkizidis

© Brammertz Consulting, 20092Date: Static - Dynamic > Static > Dynamic

© Brammertz Consulting, 20093Date: Taxonomy of Analysis 3

© Brammertz Consulting, 20094Date: Financial events e1e1 e2e2 e3e3 enen … Investment Horizon Income Liquidity Sensitivity Value Risk Dynamic Simulation Markets Counter- parties Behavior Contracts Natural Time Markets Counter- parties Behavior Contracts

© Brammertz Consulting, 20095Date: Volatility in t 0 (  ) Time to Maturity Yield Static Analysis Time Liabilities Assets t0t0 Existing Business NPV

© Brammertz Consulting, 20096Date: P&L Yield curve t 1 Yield curve t 2 Time to Maturity Yield curve t 0 Yield Spread Dynamic Analysis Time Liabilities Assets New Business t0t0 Existing Business New volume /reinvestment Type of new business Pricing

© Brammertz Consulting, 20097Date: Static analysis vs. going concern > Reasons why going concern is important > Life is a flow (and so is finance) > Relative obscurity of the going concern view > Increasing importance > CCAR

© Brammertz Consulting, 20098Date: Elements of dynamic simulation > Market forecast > Other risk factors (Counterparties, Behavior) > New production (of financial contracts) > Operational cost (and revenues)

© Brammertz Consulting, 20099Date: Market Forecast > Forward rates > <> Economic forecast > Biased > Economic forecast, real world (see chapter 4) > Techniques > What-If > Monte Carlo

© Brammertz Consulting, Date: New production Volume

© Brammertz Consulting, Date: Conflicting volume targets > Different strategy elements affect volumes > Reinvestment > Behavioral > Target volumes > Order of execution > Needs conflict resolution > Target volume is last > „Not in addition“ > „In addition“

© Brammertz Consulting, Date: New production I Contract characteristics > Main characterisitcs (no unnecessary detail!) > Contract type > Tenor > Repricing > Cycles (depending on CT) > Few others... (depending on CT)

© Brammertz Consulting, Date: New production II Adding new contract volume

© Brammertz Consulting, Date: New production III Turning volume into contracts

© Brammertz Consulting, Date: New production IV Pricing > Par rate in case of non-PAM‘s!

© Brammertz Consulting, Date: New production Pricing under credit risk

© Brammertz Consulting, Date: Behavior and counterparty > Behavior > Normaly kept constant during dynamic simulation runs > Exception: stress testing > Stochastic behavior: possible option for future > Counterparty > Unrealistic to simulate single counterparties > Exception: very large exposures > Simulation on the level of rating groups

© Brammertz Consulting, Date: Operational cost and „other revenues“ > Cost in static analysis normally neglected (if Δ t=0, cost does not really exist) > To neglect cost in dynamic analysis means enjoying a fantastic profitability (but only on paper) > This can be easily seen in the dynamic balancing equation

© Brammertz Consulting, Date: Financial analysis and book keeping > Where are the book keepers statements? > Where is the chart of accounts > Closely related to the concept of balancing > Distinguish between > Static analysis > Dynamic Analysis

© Brammertz Consulting, Date: Balancing Static > The static balancing equation > How is an inequality possible in t 0 ?

© Brammertz Consulting, Date: Dynamic balancing On book-keepers terms only > Example: > Asset is simple coupon bearing bond 10% > Liability is simple (linear) zero-coupon bond 10% > Contradiction: P&L is 0 but equity shrinks: dynamic balancing equation is violated

© Brammertz Consulting, Date: Dynamic balancing On treasurers terms (then book keeping) > Conclusion: Banks balance in reality on cash flow basis > Books balance only after balancing on cash flow basis