© Brammertz Consulting, 2009 1Date: 20.04.23

Unified Financial AnalysisRisk & Finance Lab

Chapter 13: The going-concern view / General mechanisms

Willi Brammertz / Ioannis Akkizidis

© Brammertz Consulting, 2009 3Date: 20.04.23

Taxonomy of Analysis

3

© Brammertz Consulting, 2009 4Date: 20.04.23

Financialevents

e1 e2 e3 en…

Investment Horizon

Income

Liquidity

L@R E@R V@R

Sensitivity

Value

Risk

Dynamic Simulation

Markets

Counter-parties

Behavior

Contracts

Natural Tim

e

Markets

Counter-parties

Behavior

Contracts

© Brammertz Consulting, 2009 5Date: 20.04.23

Volatility in t0 ()

Time to Maturity

Yield

Static Analysis

Time

Liabilities

Assets

t0

Existing Business

Existing Business

NPV

© Brammertz Consulting, 2009 6Date: 20.04.23

...

P&L

Yield curve t1

Yield curve t2

Time to Maturity

Yield curve t0Yield

Spread

Dynamic Analysis

TimeLiabilities

Assets New Business

New Business

t0

Existing Business

Existing Business

•New volume /reinvestment•Type of new business•Pricing

© Brammertz Consulting, 2009 7Date: 20.04.23

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, 2009 8Date: 20.04.23

Elements of dynamic simulation

> Market forecast

> Other risk factors (Counterparties, Behavior)

> New production (of financial contracts)

> Operational cost (and revenues)

© Brammertz Consulting, 2009 9Date: 20.04.23

Market Forecast

> Forward rates > <> Economic forecast

> Biased

> Economic forecast, real world (see chapter 4)

> Techniques> What-If

> Monte Carlo

© Brammertz Consulting, 2009 10Date: 20.04.23

New productionVolume

© Brammertz Consulting, 2009 11Date: 20.04.23

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, 2009 12Date: 20.04.23

New production IContract characteristics

>Main characterisitcs (no unnecessary detail!)

> Contract type

> Tenor

> Repricing

> Cycles (depending on CT)

> Few others... (depending on CT)

© Brammertz Consulting, 2009 13Date: 20.04.23

New production IIAdding new contract volume

© Brammertz Consulting, 2009 14Date: 20.04.23

New production IIITurning volume into contracts

© Brammertz Consulting, 2009 15Date: 20.04.23

New production IVPricing

> Par rate in case of non-PAM‘s!

© Brammertz Consulting, 2009 16Date: 20.04.23

New productionPricing under credit risk

© Brammertz Consulting, 2009 17Date: 20.04.23

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, 2009 18Date: 20.04.23

Operational cost and „other revenues“

> Cost in static analysis normally neglected (if Δt=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, 2009 19Date: 20.04.23

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, 2009 20Date: 20.04.23

BalancingStatic

>The static balancing equation

>How is an inequality possible in t0?

© Brammertz Consulting, 2009 21Date: 20.04.23

Dynamic balancingOn 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, 2009 22Date: 20.04.23

Dynamic balancingOn treasurers terms (then book keeping)

> Conclusion: Banks balance in reality on cash flow basis

> Books balance only after balancing on cash flow basis