Default Risk Capital Requirement for Non-Securitisations

The notional amount is used to determine the loss of principal at default, and the mark-to-market loss is used to determine the net loss so as to not double-count the mark-to-market loss already recorded in the market value of the position. (1) For all instruments, the notional amount is the notional amount of the instrument relative to which the loss of principal is determined. Examples are as follows: (a) For a bond, the notional amount is the face value. (b) For credit derivatives, the notional amount of a CDS contract or a put option on a bond is the notional amount of the derivative contract. (c) In the case of a call option on a bond, the notional amount to be used in the JTD calculation is zero (since, in the event of default, the call option will not be exercised). In this case, a JTD would extinguish the call option’s value and this loss would be captured through the mark- to-market P&L term in the JTD calculation. (2) Table 1 illustrates examples of the notional amounts and market values for a long credit position with a mark-to-market loss to be used in the JTD calculation, where: (a) the bond-equivalent market value is an intermediate step in determining the P&L for derivative instruments; (b) the mark-to-market value of CDS or an option takes an absolute value; and (c) the strike amount of the bond option is expressed in terms of the bond price (not the yield). Examples of components for a long credit position in the JTD calculation Table 1 Instrument Notional Bond-equivalent market value P&L Bond Face value of bond Market value of bond Market value - face value CDS Notional of CDS Notional of CDS -| mark- to-market (MtM) value of CDS | -| MtM value of CDS | Sold put option on a bond Notional of option Strike amount -| MtM value of option | (Strike -| MtM value of option |) - Notional Bought call option on a bond 0 MtM value of option MtM value of option P&L = bond-equivalent market value - notional. With this representation of the P&L for a sold put option, a lower strike results in a lower JTD loss. The convertible bonds are not treated the same way as vanilla bonds in computing the DRC requirement Banks should also consider the P&L of the equity optionality embedded within a convertible bond when computing its DRC requirement. A convertible bond can be decomposed into a vanilla bond and a long equity option. Hence, treating the convertible bond as a vanilla bond will potentially underestimate the JTD risk of the instrument. 8.15 To account for defaults within the one-year capital horizon, the JTD for all exposures of maturity less than one year and their hedges are scaled by a fraction of a year. No scaling is applied to the JTD for exposures of one year or greater. 35 For example, the JTD for a position with a six month maturity would be weighted by one-half, while the JTD for a position with a one year maturity would have no scaling applied to the JTD.