The Hindu Business Line : Knowledge at risk if you're asking what's VaR

ACCOUNTANTS know debits and credits as much as the palm of their hands. But Moorad Choudhry's Structured Credit Products, from Wiley (www.wiley.com) belongs to a different league. It is about `credit derivatives and synthetic securitisation.' The preface begins by describing `credit risk' as the risk that the bond or loan issuer will default on the debt; and `credit derivatives' as what the market uses to hedge credit risk.

Part I of the book is on credit risk and credit derivatives. Using a simple style, the author explains some of the basic concepts. Thus, credit risk can either be credit default risk or credit spread risk. Default is `technical' when, for instance, a company does not meet its interest payments on a loan for three months or more, but is not bankrupt. What is credit spread risk? It is the risk of financial loss resulting from changes in the level of credit spreads used in the marking-to-market of a product, explains Choudhry.

In 1994, JPMorgan launched RiskMetrics free over the Net, and introduced the methodology of `Value-at-Risk' or VaR, as a measure of the worst expected loss that a firm may suffer over a period of time. Using VaR, you can gauge the possible losses from a portfolio under `normal' circumstances. Calculations can become complex when simulation enters the picture. Not knowing all these may lead to a high KaR, or knowledge-at-risk!

The chapter on credit derivatives notes that over the decade that these have been around, volumes have risen. According to the British Bankers Association, credit derivatives were estimated at $4 trillion for 2004. A chart shows how `credit default swaps' account for almost half of the credit derivatives market; in the other half are other types, such as CDO or collateralised debt obligation, credit linked note, asset swap, total return swap and so on.

Know that credit derivatives can be funded or unfunded. The funded one uses a CLN or credit-linked note. "The investor in the note is the credit-protection seller and is making an upfront payment in the note to the protection buyer when it buys the note," and the upfront payment is the CLN's price, while the protection buyer is the issuer of the note, elucidates the author. "If no credit event occurs during the life of the note, the redemption value (par) of the note is paid to the investor on maturity," else the investor gets less. The unfunded type does not involve upfront payment.

Part II of the book deals introduces synthetic securitisation as "a generic term covering structured financial products that use credit derivatives in their construction," and explains securitisation as "the sale of assets, which generate cash flows from the institution that owns the assets, to another company that has been specifically set up for the purpose of acquiring them." The newborn, called SPV, SPE or SPC, that is, special purpose vehicle, entity or company, helps lighten the balance sheet of the sponsor.

When the originator doesn't transfer the underlying assets, but only credit risk associated with them, synthetic CDO arises. Advantage is the continuation of customer relationships with the original bank or institution.

Valuable analysis that's worth synthesising with traditional accounting knowledge.

TRIPS trip

WHAT'S common between the new `product patent regime' introduced by an Ordinance a few days ago, and our Commerce Minister talking about a holistic legislation on `data protection'? Trade Related Intellectual Property Rights or TRIPS, that accountants cannot afford to ignore. Thus, the work by M. B. Rao and Manjula Guru, titled Understanding TRIPS, from Response Books (www.indiasage.com) is what is worth leafing through to figure out the recent happenings on.

Since 1890s there have been international efforts to govern IPRs or Intellectual Property Rights. The Paris Convention looked at protection of industrial property, while the Berne Convention devoted attention to literary and artistic works. The Universal Copyright Convention of 1952, and the Rome Convention of 1961 were for protection of performers, phonograms, and broadcasting organisations. Then came the rift between the developed world and the developing; the former wanted higher protection for IPRs, and the latter, more flexible standards.

The WTO's agreement negotiated in the 1986-94 Uruguay Round, introduced intellectual property rules into the multilateral trading system for the first time, because ideas and knowledge are an important part of trade. Rao and Guru interpret the TRIPS Agreement, devoting separate chapters to copyrights, trademarks, industrial designs, patents, layout designs of integrated circuits, protection of undisclosed info, control of anti-competitive practices, and so on.

Towards the end, the authors pose a question: "Is there a real need to strengthen IPRs?" They cite a study that found no correlation between IPR and FDI. And there is another poser: Is TRIPS outdated?

Catch up with the debate, armed with the book!

BooksOfAccount@TheHindu.co.in

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Taxing justice?

The political economy of tsunami

A case of oppression to rely on

Let not financing be a disaster after rapid onset of natural disasters

FDI in retailing — Short-changing the kirana store?

On course to a majority mess-up

Homeless and alone

Knowledge at risk if you're asking what's VaR

OBC complaints

Sugar price rise