Infinity Platform Credit Simulator User's Guide: Version 99.1, NT

Infinity Platform
Credit Simulator User’s Guide
Version 99.1, NT
CONFIDENTIAL
Infinity Credit Simulator v99.1 User’s Guide
March 1999
Notice
Infinity Financial Technology, Inc. (Infinity) reserves the right to make changes in this
publication at any time and without notice. Infinity makes no warranties, express or implied, in
this publication. In no event shall Infinity be liable for any indirect, special, incidental or
consequential damages arising out of purchase or use of this publication or the information
contained herein.
Copyright
Unpublished work. © Copyright 1998, TrueRisk Incorporated.
This publication and the software described within it ("Materials"), constitute proprietary and
confidential information of Infinity and its suppliers. The Materials (and any information or
material derived therefrom) may not be reproduced or used, and may not be disclosed or
otherwise made available to any person, in whole or in part, except in accordance with a
written agreement with Infinity or as otherwise expressly authorized in writing by Infinity.
Licenses and Trademarks

Market Simulator is a trademark of TrueRisk Incorporated
TrueRisk is a registered trademark of TrueRisk Incorporated
Infinity, the Infinity logo, Fin ++, Infinity Platform, Infinity Derivatives and Infinity RiskView
are registered trademarks or trademarks of Infinity Financial Technology, Inc. in the United
States and foreign countries. All other company or product names are trademarks or registered
trademarks of their respective holders.
Infinity Technical Support

If you wish to contact Infinity’s technical support staff, use the appropriate e-mail address
from the list below. These addresses ensure that your query is sent to both your local
representative and to Headquarters Technical Support in Mountain View.
Americas na_helpdesk@infinity.com
Asia, Australia, Pacific ap_helpdesk@infinity.com
Europe, Middle East, Africa emea_helpdesk@infinity.com
To reach Headquarters Technical Support via telephone, contact your local Infinity
representative. After local office hours, please call Headquarters Technical Support at (415)
940-6100.
Infinity Online
The Infinity Client Services web site has downloadable online documentation, answers to
frequently asked questions, call tracking, and other technical information. The website can be
found at:
http://www.infinity.com/client_services/
Contact your Infinity representative or Infinity Technical Support for a login name and
password.
ii
User’s Guide
CONTENTS
PART A GETTING STARTED ............................................................................................................................ A-5

CHAPTER 1 INTRODUCTION TO CREDIT SIMULATOR .................................................................................... A-7
What is Credit Simulator?..................................................................................................................................A-7
About this Manual............................................................................................................................................A-14
Alert Symbol.....................................................................................................................................................A-14
Installing the Software .....................................................................................................................................A-15
Date Formats ...................................................................................................................................................A-15
Getting RiskMetrics Data.................................................................................................................................A-15
Logging In........................................................................................................................................................A-15
PART B USING CREDIT SIMULATOR ...........................................................................................................B-17
CHAPTER 2 SIMULATION STEP BY STEP .........................................................................................................B-19
Defining the Portfolio and Market Data..........................................................................................................B-19
Navigating The Application .............................................................................................................................B-20
CHAPTER 3 CREDIT AND NETTING DATA ......................................................................................................B-23

Internal and External Counterparties..............................................................................................................B-23
Counterparty Data ...........................................................................................................................................B-23
Netting Agreements..........................................................................................................................................B-25
CHAPTER 4 CREATING SCENARIOS ................................................................................................................B-29

Creating Monte Carlo Scenarios .....................................................................................................................B-29
Creating Explicit Scenarios .............................................................................................................................B-37
Deleting Scenario Templates and Scenario Sets..............................................................................................B-41
CHAPTER 5 RUNNING EXPOSURE SIMULATIONS ..........................................................................................B-43

Index Substitutions...........................................................................................................................................B-43
Valuation Parameters ......................................................................................................................................B-46
Simulating Yield Spread Changes....................................................................................................................B-49
Running a Simulation ......................................................................................................................................B-49
Using the Display.............................................................................................................................................B-54
Using the Credit Hierarchy..............................................................................................................................B-54
Loading Simulation Results for Display ..........................................................................................................B-58
Deleting Simulation Results.............................................................................................................................B-66
Exiting the Application ....................................................................................................................................B-66
CHAPTER 6 MENU COMMANDS .......................................................................................................................B-67

Global Settings.................................................................................................................................................B-68
Exposure Settings.............................................................................................................................................B-69
Credit Level Data.............................................................................................................................................B-70
Default and Recovery Data..............................................................................................................................B-72
Importing Volatility and Correlation Datasets ................................................................................................B-73
Viewing Correlation and Volatility Datasets...................................................................................................B-73
Server Query ....................................................................................................................................................B-76
View Menu Options..........................................................................................................................................B-78
Window Menu Options.....................................................................................................................................B-79
iii
Credit Simulator
PART C METHODOLOGY............................................................................................................................... C-81

CHAPTER 7 SIMULATION BASICS ....................................................................................................................C-83
Exposure Calculation Overview ......................................................................................................................C-83
The Interest Rate Process ................................................................................................................................C-86
CHAPTER 8 IMPLEMENTATION ISSUES ...........................................................................................................C-91

Curve and Scenario Interpolation ...................................................................................................................C-91
Simulating Yield Spread Changes....................................................................................................................C-92
APPENDIX 1 VOLATILITY AND CORRELATION DATASETS ..................................................................... C-93
APPENDIX 2 SYSTEM CONFIGURATION FOR DISTRIBUTED PROCESSING ........................................... C-95

Credit Simulator Components..........................................................................................................................C-95
Special Directories...........................................................................................................................................C-96
The Distributed Component Account...............................................................................................................C-97
RSH on NT .......................................................................................................................................................C-98
APPENDIX 3 12 STEPS TO USING CREDIT SIMULATOR .......................................................................... C-101

Step 1: Define the Portfolio and Valuation Association ...............................................................................C-101
Step 2: Set Parameters in the Exposure Settings window.............................................................................C-101
Step 3: Define the Credit Levels ...................................................................................................................C-101
Step 4: Define the Credit Data (Probabilities of Default, Recovery Rates)..................................................C-102
Step 5: Import Volatility/Correlation Datasets.............................................................................................C-102
Step 6: Define Counterparties ......................................................................................................................C-102
Step 7: Define Netting Agreements ...............................................................................................................C-102
Step 8: Define Scenario Set Series................................................................................................................C-103
Step 9: Define Index Substitutions ................................................................................................................C-103
Step 10: Define Valuation Parameters .........................................................................................................C-103
Step 11: Run Exposure Calculations ............................................................................................................C-103
Step 12: Viewing Simulation Results ............................................................................................................C-104
iv
User’s Guide
Part A
GETTING STARTED
v
Credit Simulator
A-6
User’s Guide
Chapter 1 Introduction to Credit Simulator
What is Credit Simulator?

Credit Simulator is a general-purpose, high-performance tool for measuring
credit risk in trading portfolios. It has been specifically designed to:
• Measure credit exposure (expected and "worst-case") over the life of the
portfolio.
• Take into account the effects of credit mitigation tools such as netting
agreements.
• Provide analysis of credit exposure at different levels of aggregation, using a
flexible hierarchy structure.
Credit Simulator features multi-period Monte Carlo simulation. Its architecture
enables the distributed processing of large portfolios of complex instruments.
For each time period in the Monte Carlo simulation, the potential exposure to a
particular counterparty has a probability distribution. From this probability
distribution, one can infer the "expected" value of the exposure and other
relevant statistics. Credit Simulator provides the full distribution of exposure at
A-7
Credit Simulator
each selected horizon.

Credit Simulator also gives summary information for the expected exposure (or
“average exposure”) and the "worst-case" exposure over the time horizon of the
whole simulation. Note: “Worst-case” is defined as the exposure that will not be
exceeded with a given level of confidence (e.g. 95% of the time).
Infinity Platform Integration
Credit Simulator is integrated with the front, middle, and back office of the
Infinity Platform product line.
Market Simulator Credit Simulator

•
Simulation Toolkit Extended Simulation Toolkit
Valuation Market Customer

Environment Environment Information
Manager Manager Manager
Fin++
Data Model
A-8
User’s Guide
Major architectural improvements to the simulation engines accommodate the

heavier simulation load necessary in credit exposure calculations. As a result of
these improvements, Credit Simulator can perform near real-time calculations.
Credit Simulator operates as follows:
• Periodic (e.g. daily) runs are used to calculate the bulk of the exposures.
• Intraday incremental updates are made as trades are entered.
• Fully distributed processing produces truly scaleable performance.
Credit Simulator Components
The simplified diagram below illustrates the three major components of Credit
Simulator:
1. Data
2. Exposure Calculation Engine
3. Portfolio Credit Exposure Analysis
Credit Data Position Market Data Market Data Valuation

Data Forecast Parameters Parameters
Scenario Set Series
EXPOSURE CALCULATION
ENGINE
Exposure
Set
Netting Portfolio Exposure

Hierarchy Analysis
A-9
Credit Simulator
Data Requirements
Data integration is a major implementation issue for any credit risk management
system. The required data is generally derived from different sources, both
internal (e.g. position data) and external (e.g. market data) sources. In this arena,
Credit Simulator has the advantage of the proven Infinity Data Model.
Extensions have been made to the Infinity Data Model in order to accommodate
the following data requirements of Credit Simulator:
• &UHGLW'DWD Credit Simulator requires credit data including counterparty
data and netting agreements. Counterparty information is comprised of the
name of the counterparty, credit level, parent company, etc.
Legal agreements are the basis of the netting framework. Netting agreements
are available in a variety of formats, but can be defined using counterparties,
product types, currencies and the decision of whether or not to use close-out
netting. All trades that meet the selected criteria (i.e. have the specified
product type, currency and counterparty) will be grouped together for
exposure calculations. Users are able to explicitly exclude specific trades
from the group.
• &UHGLW+LHUDUFK\ Credit Simulator provides an interface for defining
credit hierarchy structures. Netting agreements are at the bottom level of the
hierarchies (unless the hierarchies have been sub-divided by internal
counterparty or book). Above the netting agreements, the nodes might
represent industry classifications, countries, credit ratings, etc.
• 3RVLWLRQ'DWDDQG0DUNHW'DWD This data is available through the
Infinity Platform Data Model and external sources such as Telerate and
Reuters. The Infinity Derivatives trading applications can be used to edit
and view this information.
• 0DUNHW'DWD)RUHFDVW3DUDPHWHUV This information set is used by the
analytical model to generate forward-interest-rate and exchange-rate
scenarios over the life of the portfolio. Volatility and correlations for the
market risk factors are needed for the scenario generation. In addition,
mean-reversion speed estimates must be specified for the interest-rate
processes. A scenario set series must be generated before a simulation can
be run.
• 9DOXDWLRQ3DUDPHWHUV Finally, the user must provide the base currency,
the valuation association, and the index substitution information. This
information is required to perform the valuations.
Scenario Generation
Credit Simulator generates the full probability distribution of exposures for each
forward date. In order to generate this distribution, Credit Simulator requires a
scenario set series with scenarios at user-selected forward dates. The generation
of scenarios poses a number of challenges. Credit Simulator uses a multi-factor
interest-rate process as well as stochastic foreign exchange rate simulation
model. The interest-rate process has the following characteristics:
A-10
User’s Guide
• 0HDQUHYHUVLRQ The user specifies the estimated reversion speed and

selects either forward rates or current spot rates as the expected mean of the
term-structure.
• 1RQQHJDWLYHLQWHUHVWUDWHV A lognormal process is used. This is
important for long-term simulations, where higher volatilities could
otherwise result in negative rates.
• $UELWUDJHIUHH The process can be used to generate scenarios consistent
with current market data.
• 0XOWLFXUUHQF\ The scenario values match the current correlation and
volatility data across all currencies.
• 6WUDWLILHG6DPSOLQJ Credit Simulator uses an improved scenario
generation method based on stratified sampling. The distributions of price
changes are divided up into sections and each section is sampled only once.
This reduces the ‘lumpiness’ of the scenarios, greatly improving accuracy
and reducing the number of scenarios necessary. Several numerical
refinements have been implemented to improve consistency and to
accommodate imperfections in the estimation of the input parameters.
100 Scenarios, Random 100 Scenarios Stratified

based Monte Carlo Sampling
20% 20%
16% 16%
12% 12%
8% 8%
4% 4%
0% 0%
-1.02 -0.60 -0.17 0.25 0.67 1.10 -1.07 -0.64 -0.21 0.22 0.66 1.09
DEM/USD FX Rate Frequency Distribution
Exposure Calculation Engine
Once the scenario sets have been generated and all the other required data has
been defined, the exposure calculations can be performed. The following
process is used:
• Each transaction is valued for each scenario at each point, using a standard
mark-to-market routine.
• The transaction exposures (the total mark-to-market values) are aggregated
by netting agreement or, if desired, by book or internal counterparty for each
netting agreement.
• The aggregated exposures are saved to the data model. For each netting
agreement, two values are saved: the sum of positive mark-to-market values
and the sum of the negative mark-to-market values.
A-11
Credit Simulator
Portfolio Exposure Analysis
The portfolio analysis component of Credit Simulator combines the output of the
exposure calculation engine (the exposure set) with the flexible credit hierarchy
scheme to provide analysis of all results to a user-defined level of detail and
aggregation. For a given aggregation level (e.g. country, industry, counterparty),
the user may:
• view aggregated exposure over time,
• view probability distribution of exposure at a given time horizon,
• drill-down across the hierarchy levels,
• display scenarios for points on each path, and
• view expected credit losses.
Credit Simulator uses default probabilities and recovery rates to calculate a
credit loss profile for a portfolio:
CL = CE * DP * ( 1 - RR)
Where:
CL = Credit Losses
CE = Credit Exposure
DP = Default Probability
RR = Recovery rate.
Default probabilities and recovery rates are assumed to be non-stochastic, but
can be different for each time horizon. In order to calculate a credit loss profile,
Credit Simulator requires matrices of default probability and recovery rates.
Dual Set Model
The computational load for credit exposure calculations is very high. At the
same time, there is a business need for near real-time functions such as pre-deal
exposure checks and up-to-date portfolio exposures. In order to address this
tension, Credit Simulator has been designed for truly scaleable performance,
with support for distributed processing.
A-12
User’s Guide
In addition, Credit Simulator uses a dual-set model, as shown below.
Data Model
Calculation
Engine
Semi real-time
Update Engine
Working Set When Complete Current Set
Analysis
The first result set is calculated from scratch. When the result set is complete, it
is continually updated as new trades are entered into the system. While the first
result set is being updated, it is referred to as the “current set.”
At the same time that the first (or current) set is being updated, a second result
set is being calculated from scratch. This is the “working set.” When the
working set is complete, it will become the current set and the original current
set will be discarded.
The current set is up-to-date since it contains all of the current trades. However,
the market data and simulation assumptions (e.g. volatilities and correlations)
may be old. The market data and simulation assumptions are only updated
periodically, when a new working set is started.
The raw exposures (and losses where appropriate) are maintained in memory
(either all in RAM or loaded from disk and cached as required). The current set
and the working set are being calculated at any given time. The current set
contains a full set of results that have been completely calculated and are
updated as new trades are transacted. The current set is used for any user queries
and reports.
Simultaneously, the working set is calculated, but from the beginning (without
using another results set). It is also updated with new trades. When the working
set has been completed (i.e. simulations have been performed on the entire
portfolio), it becomes the current set.
A-13
Credit Simulator
With the dual-set model, it is not necessary to perform all simulations when new
trades are entered. The current exposures are updated with any recent portfolio
changes. The market data and market data forecasts are current at the initial start
of calculating that page. This calculation process is financially sound since
market data forecasts for periods far in the future (e.g., one year) change much
less frequently than the positions. Consequently, the bulk of the exposure can be
calculated periodically (for instance, daily) and intraday incremental updates are
performed as new trades are entered.
Open Model Interface
The Infinity Valuation Framework allows external pricing models to be used in

the simulation valuations. This provides and easy way to add pricing models and
new instruments. Users can either add their own models or use those of a third
party vendor.
About this Manual

This manual provides information about the use of the Credit Simulator
application. Using this guide, users should be able to produce risk measurement
analyses and interpret them correctly. The manual is divided into three parts.
Part A, Getting Started, is intended to give users an overview of Credit
Simulator’s functionality.
Part B, Using Credit Simulator, provides detailed information about the
menus, screens, data inputs, outputs, and other aspects of Credit Simulator’s
functionality.
Part C, Methodology, offers a brief overview of simulation techniques used by
Credit Simulator and a discussion of certain implementation issues.
While providing an introduction to credit risk measurement and a description of
the quantitative techniques used in the software, the manual is not intended as an
exhaustive account of credit risk management practices, or a rigorous
mathematical derivation of all the formulae used. Several publications deal
specifically with these topics, including: (1) Federal Reserve System Task Force
on Internal Credit Risk Models, “Credit risk models at major US banking
institutions: Current state of the art and implications for assessments of capital
adequacy,” May 1998, (2) J. P. Morgan, “CreditMetrics, Technical Document,”
April 1997, (3) Credit Suisse Financial Products, “CreditRisk+: A Credit Risk
Management Framework,” 1997, and (4) Meridian Research Inc., “Credit Risk
Management Technologies,” Feb. 1998.
Alert Symbol
The alert symbol (shown at the left) is used in this manual to indicate important
points that should not be ignored.
A-14
User’s Guide
Installing the Software

Your system administrator should install the software. The ‘README’ file on
the CD contains information about proper configuration of the system.
Date Formats
The format used to display dates in Credit Simulator is borrowed from the
operating system. This is set using the Date tab in the Regional Settings
program. The Regional Settings program can be run from the Control Panel on
the Settings section of the Windows NT Start menu.
Getting RiskMetrics Data

The Credit Simulator scenario generation requires volatility and correlation data
for the calculations. This data can be provided by the user or can be obtained
from the RiskMetrics dataset. The RiskMetrics dataset is available from the
Internet (as well as other sources). It is updated daily, and made available by J.
P. Morgan and Reuters at no charge. The Credit Simulator application is able to
get the data from the Internet. For this functionality to work, the network on
which the application resides must have an Internet/World Wide Web
connection.
Logging In
Start the application by selecting Credit Simulator from the Start Menu or by
double-clicking on a Credit Simulator shortcut on the Windows desktop. If the
user has a valid infLogin.default file, the application will automatically log into
the appropriate database. Otherwise, the login window (shown below) will be
invoked.
To connect to a server or database, input the proper information in the relevant

fields. Either press the <Tab> key to move between fields in the window or left-
click on the desired field.
A-15
Credit Simulator
Type the name of the database server, specific database and username you will
use for this. Enter your pre-assigned password in the Password field. To protect
your password, asterisks are displayed in this field as you type the characters of
your password. Your database system administrator is responsible for ensuring
that you have the appropriate data for these fields. If you would like to use these
entries during subsequent Credit Simulator logins, check the “Save Login
Information” box. You will be required to re-enter the password for subsequent
logins, but the other information will be provided. To complete the login, press
<Enter> after you have entered the necessary information or left-click on the OK
button.
If the login is incomplete or invalid, an error message window will appear.
Update the information in the Login window. If repeated attempts to access the
database do not succeed, see your database system administrator to verify that
your login information is up-to-date.
Once you have logged in, you may work only in the database you specified in
the login window. To work in another database, you must log in again.
Credit Simulator must be logged into a database that utilizes the correct version
of the Infinity Data Model and the correct version of Credit Simulator. If the
versions are incompatible, the login will typically fail and there will be a
database error written to the console.
A-16
User’s Guide
Part B
USING CREDIT SIMULATOR
B-17
Credit Simulator
B-18
User’s Guide
Chapter 2 Simulation Step by Step
Full valuation simulation involves three steps generating scenarios, running

exposure calculations and analyzing the results. The prerequisite data for each
step are described below.
SIMULATION STEPS
Step 1: Generate Scenarios
This step requires volatility and correlation data as well as mean reversion
speeds for interest rates.
Step 2: Run Exposure Simulation
This step requires a scenario set series, portfolio and market data, valuation
parameters, index substitutions, a valuation association and counterparty and
netting agreement data.
Step 3: Analysis
This step requires the results of the simulation run: an exposure set. It also
requires a credit hierarchy.
NOTE: For an outline of functional steps for using Credit Simulator, see
Appendix 2 on page C-95.
Defining the Portfolio and Market Data

Transaction data and current market rates are stored in the Infinity Data Model.
The data and rates can either be imported from other trading or back office
systems or can be entered using an Infinity application. Credit Simulator
requires the following information:
• all transactions/trades
• a portfolio definition, specifying which trades are to be included in the
simulation
• appropriate yield curves for all the trades
• a repo curve group if the portfolios include bond futures or options
• appropriate volatility curves and volatility surfaces for all the trades
• a valuation association defining which curves should be used for given
trades
B-19
Credit Simulator
• current foreign exchange data for all the currencies in the portfolios
• reset rates for the indexes and most recent reset dates for all floating
rates in the portfolios
Navigating The Application

Credit Simulator’s Navigation Panel is located on the left side of the window.
This Navigation Panel is used to access the data and to perform most of the
application’s functions. The Navigation Panel has six sections that are selected
by clicking on the appropriate bar:
• Counterparties (see page B-23)

• Netting Agreements (see page B-25)
• Scenarios (see page B-29)
• Index Substitutions (see page B-43)
• Valuation Parameters (see page B-46)
• Results (see page B-49)
Each section contains a tree showing the relevant data. In addition, there is a
popup menu (invoked by right-clicking in the hierarchy tree area) that provides
access to the data and performs various functions.
The following table provides a map of the application screens.
B-20
User’s Guide
SIX SECTIONS (Navigation Panel) CONTENTS MENU COMMANDS (right-click in Navigation Panel)
Counterparties Counterparty New (B-23)
(see page B-29) Data Edit (B-24)
Delete (B-24)
Netting Netting New (B-25)
Agreements Agreement Edit (B-25)
(see page B-25) Definitions Delete (B-25)
Scenarios Scenario Edit (B-36, B-37)
(see page B-29) Templates / Define and Create Explicit Scenarios (B-37)
Scenario set Create Explicit Scenarios (B-37)
Series View (B-30)
Define MC Template (B-30)
Create MC Scenarios (B-29)
Delete (B-41)
Index Index New (B-43)
Substitutions Substitutions Edit (B-43)
(see page B-43) Delete (B-46)
Valuation Valuation New (B-47)
Parameters Parameters Edit (B-47)
(see page B-46) Delete (B-49)

Results Hierarchies Edit Hierarchy (B-55)
(see page B-49) New Hierarchy (B-54)
Delete Hierarchy (B-55)
Insert Level (B-55)
Delete Level (B-55)
Expand All (B-55)
Collapse All (B-55)
Results Edit (B-49)
New (B-49)
Delete (B-49)
Run (B-52)
Load Results (B-58)
Create Report (B-65)
Netting Type (B-66)
Display (B-66)
B-21
Credit Simulator
B-22
User’s Guide
Chapter 3 Credit and Netting Data
Credit Simulator requires credit data to group exposures into specific categories
(such as country and credit rating or level). It also needs netting agreement data
to determine which trades can be netted together. The credit hierarchy is used to
facilitate the analysis and display of simulation results.
Internal and External Counterparties

Every trade has two counterparties, typically one selling and one buying (or one
receiving and one paying). When a credit exposure calculation is performed, it is
calculated from the perspective of one counterparty or group of counterparties.
These counterparties are the ‘us’ counterparties in the analysis. Credit Simulator
measures ‘our’ exposure to the other counterparties. The ‘us’ counterparties are
referred to as the bank in Credit Simulator. In this document, they will also be
called internal counterparties.
Typically, all internal or “bank” counterparties will have the same ultimate
parent. This is the parent from whose perspective the exposure is measured and
is the same entity that is designated as the bank in the exposure set definition. A
counterparty that does not have the bank as its ultimate parent is an external
counterparty. Trades can be performed between two internal counterparties, for
example, when both counterparties in a particular trade have the bank as a
parent. In this case, there is no credit exposure and Credit Simulator will ignore
the trade. Similarly, trades between two external counterparties will also be
ignored.
Credit Simulator can break out exposures according to internal counterparty.
This option is set in the Exposure Settings dialog. Counterparties that will
potentially be used as the bank in an exposure set definition should be
designated as ‘can be bank’ in the counterparty data dialog. All the descendants
of a top-level bank counterparty should have the "can be bank" status set.
Counterparty Data
Data must be provided for each counterparty whose trades will be included in
the simulation. This data is used to aggregate the exposure for analysis purposes
and to determine default probabilities for calculating expected losses.
B-23
Credit Simulator
To enter or modify counterparty data, select the Counterparties section of the

Navigation Panel. All counterparties for which data has been defined will be
listed. To enter data for a new counterparty, left-click in the Navigation Panel
and select New from the popup menu. This will invoke the Counterparty editor.
Select the name from the drop-down list box. This list contains all the
counterparties defined in the Infinity Data Model. The other fields will
automatically be filled with data from the data model. You may edit any of the
data in the relevant field. The fields of the Counterparty editor are described
below. Select the OK button to save the data to the database or the Cancel
button to discard changes.
To edit the counterparty data for any counterparty in the list, left-click on the
counterparty name and select Edit from the popup menu. Edit the data as
required and press OK to save the changes.
To delete a counterparty, left-click on its name in the Navigation Panel. Then
right-click and select the Delete menu command. You will be asked to confirm
that you wish to remove the selected counterparty information.
Name
The Name field contains the name of the counterparty. It is the key to identifying
trade and exposure data throughout the system. All counterparties must be
defined in the system using the Infinity’s Customer Information Manager
application.
B-24
User’s Guide
Description
The Description field is for informational purposes only. This field is optional.
Parent Entity
The Parent Entity is the legal parent of the counterparty. Like the child entity,
the Parent Entity must be a valid counterparty defined in the Data Model. In the
Counterparty window of Credit Simulator, enter the parent counterparty before
creating the child entity (so that you will be able to select the appropriate parent
entity in this field).
Credit Level
The Credit Level field indicates the credit quality of the counterparty and is
equivalent to a credit rating. It is used for aggregating exposure by credit quality
and for determining the default probabilities used in loss calculations. The credit
levels are defined using the Credit Level window (Settings: Credit Levels).
Either credit ratings from a rating agency or a bank’s own internal ratings can be
used as the source of the Credit Level. Once the Credit Levels are defined, you
must enter associated recovery rates and default probabilities in the Credit Level
Data window (Settings: Credit Data). If you do not enter the recovery rate and
default probability information, it will not be possible for Credit Simulator to
calculate losses. For more information about the Credit Level and Credit Level
Data windows, see the Menu Commands chapter.
Country
This is the country of domicile of the counterparty. It is the country to which the
credit exposure will be assigned for country exposure reports.
Industry
This is the industry classification of the counterparty. It is used for reporting on

industry exposure.
Can be Bank
The “Can be Bank” checkbox is used to identify the counterparties of the bank
for which the credit exposure is being calculated (i.e. internal counterparties).
Typically, all counterparties for which this checkbox has been selected will have
the same ultimate parent counterparty the primary business entity of the
credit exposure analysis. The “Can be Bank” checkbox is used to identify those
counterparties that can be defined as the bank in an exposure set definition.
Consequently, the “Can be Bank” checkbox should be selected for all the
descendants of the bank.
Netting Agreements
Netting agreements are the building blocks of the exposure simulation reports. A
netting agreement in Credit Simulator represents a group of trades with a
particular counterparty that is treated equally for credit purposes. This is
equivalent to a master agreement in practice.
B-25
Credit Simulator
These trades may or may not be nettable against each other. The exposure results
are saved according to the netting agreement. If a trade does not fall under one
of the netting agreements defined in the system, an artificial netting agreement
will be automatically generated by the system to save the exposure data and will
be used in the credit hierarchy for analysis purposes. Note that the primary leg of
a trade determines how the trade will be handled for netting purposes. All legs
of a trade are handled as a unit.
Select the Netting Agreement section of the Navigation Panel. You will see a list
of all the netting agreements defined in the system. The netting agreements
determine which trades can be netted together for exposure calculations. Credit
Simulator only considers close-out netting. IMPORTANT: Netting agreements
can be entered that explicitly FORBID netting. In other words, if trades are
covered by a master agreement that does not allow close-out netting, these
agreements should be entered as non-Netting Agreements by deselecting the
“Close-out Netting” check box (described below).
To add a new netting agreement, right-click in the Navigation Panel and select
New from the popup menu. To edit an existing agreement, select that agreement,
right-click and choose Edit. Either of these commands will invoke the Netting
Agreement window (described below). To delete a netting agreement, select the
desired agreement, right-click in the Navigation Panel and select the Delete
command. You will be asked to confirm the deletion.
B-26
User’s Guide
ID
In the Netting Agreement window, the ID number identifies the agreement in

the system. This unique number is automatically assigned by the system and
cannot be modified by the user.
Description
This field contains a description of the agreement. It is provided for information

purposes only and is optional.
Banks
To utilize a particular netting agreement, a trade must have one counterparty that
has been selected in the Included Banks list and another counterparty that has
been selected in the Included Counterparty list of the Netting Agreement
window. See the section “Internal and External Counterparties” for a more
detailed explanation of these categories. Select the bank counterparties in the
Available Banks list and use the >> button to add them to the Included Banks
list.
Counterparties
To utilize a particular netting agreement, a trade must have one counterparty that
has been selected in the Included Banks list and another counterparty that has
been selected in the Included Counterparty list. See the section “Internal and
External Counterparties” for a more detailed explanation of these categories.
Select the desired counterparties from the Available list and use the >> button to
add them to the Included Counterparties list.
Products
Only trade legs of the same type as those selected in the Included Products list
box will be selected by a particular netting agreement. Select products in the
Available List and use the >> button to add the products to the Included Product
list.
Currencies
Only trade legs denominated in an Included Currency will be included under

this netting agreement. Use the >> button to add the selected currencies from the
Available list to the Included Currencies list.
Exception Trades
This is list of trade IDs for trades that meet the bank, counterparty, product and
currency criteria for a netting agreement, but do not actually fall under the
agreement. Use this field to explicitly exclude specific trades from netting with
the other trades that fall under this agreement. Select the Add button to add a
trade ID, and Remove to remove the selected trade id from the exception list.
B-27
Credit Simulator
Effective Date
This is the date on which the netting agreement became effective. Trades with
trade dates prior to this date will not be included under the agreement.
Expiry Date
This is the date on which the netting agreement will expire. Trades with trade
dates after this date will not be included under this agreement.
Priority
Each trade leg can only be assigned to a single netting agreement. The priority is
used to resolve situations where a trade leg falls under more than one netting
agreement. Where there are two or more agreements with bank, counterparty,
product, currency, effective data and expiry date specifications that are satisfied
by a particular trade leg, the trade leg will be allocated to the agreement with the
highest priority. Select the desired priority from the drop-down list.
Typically, most agreements will have medium priority. Where certain types of
trade are specifically excluded from a netting agreement, they should be
assigned a separate agreement that has high priority (to override the medium
priority agreement. A ‘catch-all’ agreement for trades not covered by other
agreements can be given a low priority.
Close-Out Netting
The Close-Out Netting check box determines whether or not the exposure of
trades that fall under this agreement will be netted together. This check box
should be selected where a legally enforceable netting agreement is in place
between the bank and the external counterparties for the products and currencies
specified. It is possible to override this setting when analyzing individual
counterparty exposure.
B-28
User’s Guide
Chapter 4 Creating Scenarios
Using Credit Simulator, it is possible to create two types of scenarios:

• Monte Carlo Scenarios
• Explicit Scenarios
The process of generating each of these types of scenarios is described in the

corresponding sections below.
Scenario Set Series Names and

Dates
Each scenario set series must have a unique name and a date. If several scenario
sets share the same name, they each must have a different volatility and
correlation dataset date. Similarly, if two scenario sets have the same dataset
date, they must have different names. This requirement facilitates the re-use of
scenario definitions on different days and facilitates automated daily simulation
runs. The dates for the scenario sets are typically derived from the underlying
data used to generate the scenarios and depend upon the scenario generation
methodology (i.e. Monte Carlo or explicitly defined).
Creating Monte Carlo Scenarios
You must perform the following three steps in order to create a Monte Carlo
scenario set:
1. Import Volatility and Correlation Dataset 6HOHFWWKH6HWWLQJV
Import Dataset menu command.
2. Create Monte Carlo Scenario Set Template 5LJKWFOLFNLQWKH
Navigation Panel and select “Define MC Template” from the popup
menu.
3. Create Monte Carlo Scenario Set (an instanceRIWKHWHPSODWH
Right-click on the Monte Carlo template name and select “Create MC
Scenario” from the popup menu.
The steps are described in detail below. MC scenario templates are identified
with a blue diamond icon. The currently selected scenario set or template has a
red diamond icon.
B-29
Credit Simulator
Fetching the Volatility and

Correlation Dataset
One source of volatility and correlation data is the RiskMetrics dataset from J. P.
Morgan. This is provided at no cost by the RiskMetrics’s internet site.
Downloading the data can take a long time (approximately an hour) because the
amount of data is significant. The data can be downloaded via the world wide
web using a web browser. It may be preferable to have this done automatically
every day. Ask your system administrator for help with automating this process.
Once the data files have been obtained, they are loaded into the data model
using the Settings: Import Dataset main menu selection.
Appendix 1 explains how to create user-defined data files and other data-related
tasks.
Once this is accomplished, the data can be used to create Monte Carlo scenarios.
Defining a Monte Carlo

Scenario Template
Select the Scenarios section by clicking on the Scenarios bar of the Navigation
Panel. Before you can generate a Monte Carlo scenario set series, you must
create a scenario template. Right-click in the empty space of the Navigation
Panel to invoke the pop-up menu and select Define MC Template. This will
invoke the Scenario Set Series Generator window.
The Scenario Set Series Generator window is used to create a template for
generating scenarios. The same template can be used to generate many scenario
sets with different volatility and correlation Dataset dates.
NOTE: Once you have created an instance of the Monte Carlo template, you
will not be able to edit the template.
The fields of the Scenario Set Series Generator window are described below.
Viewing an Existing Monte

Carlo Scenario
Template
You must use a Monte Carlo scenario template in order to generate a Monte
Carlo scenario set series. To view an existing scenario template, select the
Scenarios bar of the Navigation Panel. Right-click on the scenario name and
select View from the popup menu. The Scenario Set Generator will appear.
You can view the Monte Carlo template information.
B-30
User’s Guide
Name
The Series Name is the name for the scenario series to be generated using this
template. As stated above, a name and a date identify each scenario series.
Description
The Series Description is an optional description field for the template. This
description will be saved with each scenario series generated with this template.
It can be used for general informational purposes.
Base Currency
The base currency is the currency in which the simulation results will be
expressed. For example, assume a scenario series is created with the base
currency set to DEM. The foreign exchange volatilities and correlations will
reflect exchange rates between DEM and the other currencies. When that
scenario series is used to calculate credit exposure, the exposure will be
expressed in DEM.
B-31
Credit Simulator
The Base Currency is not editable since it refers to the base currency of the Risk
Metrics dataset. The dataset is imported using the Settings: Import Dataset
menu command.
Number of Scenarios
This field contains the number of scenarios for each forward term in the scenario
series to be generated. A large number of scenarios will produce more accurate
simulation results. However, if there are fewer scenarios, the simulation will
take less time to run. The number of scenarios is therefore a trade-off between
accuracy and calculation time. The exact compromise chosen depends upon
what the intended use of the results, the composition of the portfolio, and the
methodology used to create the scenarios.
Random Seed
This is the seed to be used by the random number generator. Random numbers
are used in the Monte Carlo sampling process. For this purpose, any number can
be used. For a particular random number seed, volatilities, correlations and mean
reversion speeds, the identical scenario series will be generated. If the random
seed is different the scenario series will be slightly different. This difference
should not be significant.
Speed Name
This is the name of a set of user-specified mean reversion speeds to be used in

generating the forward interest rate scenarios. To add a new set of reversion
speeds, press the New button in the Scenario Set Series Generator window. This
will invoke the Reversion Speeds window.
B-32
User’s Guide
Enter the appropriate reversion speed for each currency by clicking on the Add
button (or the Edit button if you wish to modify a previously-entered reversion
speed). This will invoke the Reversion Speed window (shown below).
For most currencies, the Speed should be in the range of 0.05 to 0.2. Currencies
with very low interest rates (such as the Japanese Yen throughout much of the
1990’s) have high relative volatilities and require higher reversion speeds –
perhaps as high as 0.4 or 0.5. The mathematical range is 0 to 1. Press OK to
save the reversion speeds with the specified name. Otherwise press Cancel.
To edit or view an existing Reversion Speed set, select it from the drop-down
list and click on the Edit button. The Reversion Speed editor will appear. Press
OK to save any changes you have made. Otherwise select Cancel.
To delete a Reversion Speed set, select it from the drop-down list and click on
the Delete button.
Dataset Date
The scenario set date is the date of the dataset used for generating the scenario
set. The dataset is assigned the date on which it is created and includes closing
market prices for that day. Typically, the data becomes available the day after it
is created.
As a result, on a particular day, the exposure reports are generally run using the
current day’s portfolio and valuation date, but the dataset date of the previous
day. When scenarios are generated using the template, the dataset date from the
template will be the default. However, users will typically choose the most
current date available when generating the scenarios. The scenario series that is
created from this template will have the date of the dataset used to create it.
Dataset Name
This is the name of the dataset, defined when the dataset is entered in the Data
Model. The name can be one of the following options:
• 5LVN0HWULFV J. P. Morgan provides the RiskMetrics dataset daily. The
volatilities and correlations are calculated from historical daily data, using
exponential decay weighting.
B-33
Credit Simulator
• %,6 BIS is the RiskMetrics regulatory dataset provided by J. P. Morgan.

It is estimated using one year of historical data with equal weighting.
• 8VHU'HILQHG It is possible to generate Monte Carlo scenarios using
other datasets. These are defined by the user and can have any name.
Dataset Horizon
The Dataset Horizon is the time period for which the volatilities and correlations
apply. For example, a 1DAY time horizon means that the volatilities refer to the
volatility of one-day price movements. Similarly, the 1MONTH dataset has
monthly volatilities and correlations.
To select a dataset, click on the Edit button. This will invoke a list of available
datasets. Select the required dataset date, name and horizon and click on the OK
button. To exit the window without selecting a dataset date, select the Cancel
button.
Match Moments
Select the Match Moments check box to specify that moment matching should
be used for the scenario generations. Moment matching is a numerical technique
that increases the accuracy of simulation results for a given number of scenarios.
It is particularly useful when a small number of scenarios are being used, but it
has a significant impact on all scenario series. Generally, the user should select
the Match Moments check box (unless the user’s intention is to test the moment
matching).
Stratify
The Stratify check box activates the stratified sampling technique for generating
the samples used for the scenarios. This variance reduction technique divides the
distributions of the market factors into sections (or strata) and samples each
strata only once. This functionality dramatically reduces the number of scenarios
required for a given level of simulation accuracy. For additional information
about stratified sampling, see the methodology section of the guide. Generally,
the stratified sampling can produce results with equal or higher accuracy than
the basic Monte Carlo with approximately eight times fewer scenarios. You
should select this check box because it improves the accuracy of simulation
B-34
User’s Guide
results. The Stratify checkbox is provided as an option so that, by deselecting the

checkbox, users can easily verify the relative efficiency of the sampling.
Revert Means
The Revert Means check box determines whether mean reversion is assumed
when generating interest rate scenarios for forward terms. If the check box is
selected, interest rate movements at forward terms will be more likely to be close
to the long term mean. This will have the effect of reducing the interest rate
volatility for periods in the more distant future. The speed at which the rates
revert to the mean is specified using the Reversion Speed Name setting
(described above).
Assets
It is only necessary to include scenario elements for certain asset types in the
scenario series. The supported asset types are currencies, interest rates and
equities. If, for example, there are FX forward trades in the portfolio, it will be
necessary to include FX and interest asset types. Including unnecessary asset
types in a scenario series will increase the size of the scenario series and,
consequently, will hamper the performance of that scenario series.
Indices
To save database space and scenario series load time, it may be desirable to
exclude some of the indices from the scenario set. Select the indices you wish to
include.
Currencies Included
You may include all of the currencies in the dataset in the scenario set being
generated. However, scenario sets are very large data structures and are both
cumbersome to store and slow to load. For this reason, under most
circumstances, you should restrict the currencies in the scenario set to those that
are actually required for the simulation. Use the >> (Include) and << (Exclude)
buttons to determine which currencies are included in the scenario series.
Forward Terms Included
The Forward Terms area is used to specify which forward terms are included in
the scenario series. Any terms can be included, but adding additional terms will
slow the simulation. The relationship between the terms and simulation time is
almost linear. For example, a simulation with 20 forward terms will take twice
as long to run as a simulation with 10 forward terms.
It is not necessary for the terms to be equally spaced. In other words, it is
possible to have shorter terms for the more immediate future and longer terms
in the more distant future. Use the >> (Include) and << (Exclude) buttons to
determine which terms are included in the scenario series.
If the term you would like to use is not available in the list, type in the desired
term in days and click on the Add Custom button. This will create an entry with
the desired term.
B-35
Credit Simulator
After selecting the appropriate options, click on the OK button. If you decide
not to create the Scenario Set Series Generator template, click on the Cancel
button.
NOTE: The scenarios will not be created when you click on the OK button.
Selecting the OK button will merely define the template. In turn, this template
can be used to create the scenario series.
Creating Monte Carlo

Scenarios
Once the Scenario Set Series Generator template has been defined, you can use
it to generate scenarios. From the Scenarios section of the Navigation Panel,
select the desired scenario template. With your cursor over the desired scenario
template name in the Navigation Panel, right-click to invoke the menu and select
Create MC Scenarios. The Scenario Generation dialog window will appear.
Select the desired dataset date and click on the OK button. This will generate
Monte Carlo scenarios from the selected template. The selected date will
override the dataset date specified in the template. Generating Monte Carlo
simulations usually takes a few minutes. You will be able to identify the
scenario set series you have created by the template name and the date of the
dataset. Once you have created a date-stamped instance of the template, you will
no longer be permitted to edit the scenario template.
Editing MC Scenarios
To edit the parameters of a Monte Carlo scenario set, right-click on the date-
stamp of the scenario set and select Edit from the popup menu. This will invoke
the Scenario Set Series window. The Scenario Set Series window is described
in detail below.
B-36
User’s Guide
Creating Explicit Scenarios

Explicit scenario series are created using the Scenario Set Series window. The
Scenario Set Series window can also be used to modify any scenario set stored
in the Data Model. Explicit scenario set templates are identified with a yellow
diamond icon. (MC scenario templates are identified with a blue diamond icon.
The currently selected scenario set or template has a red diamond icon).
Select the Scenarios section by clicking on the Scenarios bar of the Navigation
Panel. To create a new explicit scenario series, right-click in the hierarchy tree
area of the Navigation Panel and select Define and Create Explicit Scenarios.
This will invoke the Scenarios Set Series editor window. (For more information
about creating a new scenario set, see the section below).
To edit an existing scenario series, select the series from the list. While your
cursor is positioned over the desired scenario series date-stamp, right-click and
choose Edit from the menu. NOTE: You must choose an actual scenario series,
not a scenario template. The series is displayed with a particular date, whereas
the template has a name, but no date. Selecting Edit from the menu will invoke
the Scenario Set Series window. For a description of the fields in this window,
see the section below.
Creating A New Scenario Set
If you want to create a new scenario set, right-click in the Scenarios section of
the Navigation Panel and select Define and Create Explicit Scenarios from the
pop-up menu. The Scenario Set Series editor (shown below) will appear.
B-37
Credit Simulator
In the Scenario Set Series editor, enter the name of the scenario set you would
like to create. If you wish, you may enter a description. The timestamp will
default to the current date and time, but can be edited. The name and date
(timestamp) combination should not be the same as any scenario set already in
the data model.
Select the base currency for the scenario set. Any foreign exchange rate scenario
elements created in this scenario set will be from the perspective of this base
currency. For example, if a scenario set base currency is GBP and it contains a
scenario element for FRF FX rates, this will refer to the FRF/GBP exchange
rate. You must now create a series of scenario sets with each scenario containing
a group of scenario elements.
If you would like to create a new instance of an existing explicit scenario
template, right-click on the name of the template and select Create Explicit
Scenarios from the popup menu. This will invoke the Scenario Set Series
window shown above.
Set
A scenario set is a group of scenarios corresponding to a particular time in the

future. The term code used for the set is added to the base value date in 30/360
basis to determine the future date. The Set drop-down list displays the term of
the currently selected set. Use the drop-down list to select the set you would like
to view or edit.
To add a new set of scenarios, click on the New button beside the Set drop-
down list. This will invoke the Select Term editor.
Type the desired number of days in the term or select a pre-defined term from
the drop-down list.
To change the term of an existing set, select the set you would like to change,
then click on the Edit button. This will invoke the same Select Term editor
invoked by the New button.
B-38
User’s Guide
Scenario
A scenario is a set of hypothetical assumptions about the future. More

concretely, scenarios are perturbations of market data. A scenario specifies
values for a group of scenario elements and those values are applied
simultaneously during valuation. The Scenario drop-down list displays the name
of the currently selected scenario. Use the drop-down list to select the scenario
you would like to view or edit. This name will be a simple number if the
scenario was automatically produced by the Monte Carlo method. For explicitly
created scenarios, you must supply a name. When the exposure sets are
analyzed, this name can be used to identify the scenario that resulted in a
particular exposure.
To create a new scenario, click on the New button beside the Scenario drop-
down list. This will invoke the Scenario name editor. Enter the required name
and click on the OK button.
Editing a Scenario Element
The element table displays all the elements of the current scenario in the current
set. To change any of the fields of an existing scenario element, left-click on the
table cell corresponding to the scenario element field you want to change. Type
or use the drop-down list to edit the value. If you want to create a new scenario
element in the currently selected scenario, click on the New button below the
element table. A new row will be added to the table. Select or type a value for
each field in the new row.
The scenario element fields are described below.
Committing Scenario Element

Changes
Click on the Commit button to change new or existing scenario elements in the
editor memory. If you do not commit changes to scenario elements, your
changes will be lost when you select a new scenario or set. The Commit button
does not save your changes to the database; it merely changes them in the editor
memory.
B-39
Credit Simulator
Saving A Scenario Set Series
When you are satisfied with your changes to the sets, scenarios and elements,
click on the OK button to save the changes to database. You can quit the editor
without saving your changes by clicking on the Cancel button.
A scenario is an arbitrary set of changes in market conditions. The requirements
to ensure that these changes are reasonable, or even arbitrage free, are complex.
Further, the scenario exists independently of the market data to which it is
applied. One obvious condition that there are no negative forward rates
can only be verified by exhaustively checking every possible forward rate on the
curve. The user is responsible for ensuring that the scenarios reasonably fit the
market conditions to which they are applied.
Currency
In the Scenario Set Series window, the Currency column holds the currency of
the index. A scenario element for a foreign exchange rate is applied to the rate
for the number of units of element currency per unit of base currency. For an
interest rate scenario element, this is the currency for which that interest rate
index is valid.
Asset Type
The Asset Type is ‘Interest’ for interest rate scenario elements, ‘FX’ for foreign
exchange rates, and ‘Equities’ for equities.
Index
The Index is used to identify different curves, even if several are in the same
currency. Often the index is used to identify a curve with a particular credit
quality, such as LIBOR or CP. For a foreign exchange scenario element, the
index is set to ‘FX’. Index substitutions are used to define which scenario
element indexes are applied to given interest rate curves.
Tenor
This is a code representing the tenor for an interest rate or interest-rate volatility
scenario element. The 1DAY tenor refers to the overnight rate, 5YEAR to the
appropriate interest rate for a five-year zero-coupon instrument, etc.
Metric Type
In the Metric Type column, “Price” indicates that the scenario element specifies
a change in the relevant discount factor or foreign exchange rate. “Rate” refers
to a change in a zero coupon interest rate or yield. “Curve Volatility” means that
the scenario element specifies a change to the volatility in a volatility curve.
“Surface Volatility” is also a volatility change, but it is applied to a volatility
surface.
B-40
User’s Guide
Change Type
This parameter has three possible values: Fractional Change, Absolute Change
and Absolute Value:
Absolute Value The scenario represents actual price or rate levels. The
values for the particular factor will be replaced with the scenario value for
valuation under the scenario.
Absolute Change The scenario element value is applied to the current date’s
data during the simulation by addition. In other words, if the 6-month LIBOR
rate scenario element had a value of 0.0013 and if 6-month LIBOR was 5.25%
on the date of the simulation, the portfolios would be valued with 6-month
LIBOR of 5.38% (5.25% + 0.13%) under this scenario.
Fractional Change The scenario element value is applied to the current
date’s data during the simulation by multiplication. For example, if a 6-month
LIBOR rate scenario element had a value of 1.0171 (fractional change), when
the current 6-month LIBOR was 5.25%, a portfolio would be valued with 6-
month LIBOR of 5.34% (5.25 X 1.0171) under this scenario.
Value
This column contains the scenario-element value (i.e., the level to which the
market factor will be set, or the amount by which it will be changed). The
Change Type determines its interpretation.
Deleting Scenario Templates and Scenario Sets

To delete a Monte Carlo or explicit scenario template (and all of the date-
stamped instances of that template), right-click on the name of the template and
select Delete from the popup menu. This deletion should be executed with care,
since it will render all dependent scenario results useless. If you wish to delete
only one instance of the template, right-click on the date-stamp and select Delete
from the popup menu.
B-41
Credit Simulator
B-42
User’s Guide
Chapter 5 Running Exposure Simulations
Before running a simulation, you will need to define valuation parameters and
index substitutions. In addition, as described in previous chapters, you will need
valid credit data (counterparties and netting agreements) and a scenario series.
In addition, the application must be configured to run correctly on your network
and with the data model. Use the Exposure Settings dialog (discussed in detail in
the Menu Commands chapter of the guide) to set up the proper configuration.
Index Substitutions
Before running a simulation, you must define Index Substitutions and specify
those substitutions using the Valuation Parameters section of the Navigation
Panel. The index substitutions provide an interface between the market data
definitions used for pricing the portfolios and scenarios that can come from
several possible sources. The scenarios define changes to various market factors,
but may not use the same names for those market factors as are used in the data
model (for mark-to-market purposes).
For example, a curve used to price a swap may be designated a LIBOR curve.
However, if a scenario is created using J. P. Morgan’s RiskMetrics data, it will
include elements referring to changes in the SWAP interest rate. The index
substitutions provide a means of specifying that the simulation should apply the
SWAP rate changes to the LIBOR curve. Substitutions can be saved and re-used
for later simulations.
Select an existing index substitution from the list in the Index Substitutions
section of the Navigation Panel. Right-click on the index substitutions required
and select Edit from the pop-up menu. The Index Substitutions Editor will
appear.
Alternatively, to create new index substitutions, right-click in the Index
Substitutions section of the Navigation Panel and select New from the menu. A
prompt will appear asking if you want to create default substitutions.
Automatically filling in defaults can save a lot of time.
The Index Substitutions Editor lists all the valid substitutions saved under a
given name. Each substitution consists of two indexes one index for pricing
the portfolio and another index in the scenario that can be used to perturb the
pricing index. Examples of portfolio pricing indices are yield curve reference
indices, volatility surface reference indices, and FX rates.
B-43
Credit Simulator
More than one substitution can be defined for a particular portfolio index.
Consequently, if a particular scenario index is not found in the scenario, the
simulation will use one of the other scenario indices defined for that portfolio
index.
Each substitution has a priority number. This number is used to determine which
scenario index should be used when more than one valid substitution index is
available. The number “1” is the preferred priority. Substitution indices with
this priority will be preferred to any others defined for the same portfolio index.
However, if a priority “1” substitution index is not available, the simulation will
use the substitution index with the next lowest priority number.
It is possible to define a default substitution that will be used for any portfolio
index of a particular currency, type and price/volatility. This is particularly
convenient if there is only one index available in the scenario. It is also useful
for preventing the simulation from failing if a new portfolio index has been
added, but no substitution has been defined for it. Create a default substitution
by selecting “DEFAULT” in the Portfolio Index column.
Press the New button to add a substitution to the list. Select the Delete button to
remove the currently selected substitution. The fields and columns of the Index
Substitutions window are described below.
Name
This is the name of the Index Substitutions. It is used to identify the

substitutions when creating valuation parameters and when running simulations.
Asset
The Asset type is FX, Interest, Equity, or Commodity.
B-44
User’s Guide
Portfolio Currency
This is the currency of the portfolio index. The same index may be defined for
several currencies (for example, USD LIBOR, GBP LIBOR, etc).
Portfolio Index
The Portfolio Index is the name of the index used for valuation of the portfolio.
For an interest rate or volatility curve or surface, this is the name of the reference
index. For a foreign exchange rate, this is set to FX. If you select DEFAULT for
an interest rate index, it will be used if no other valid substitutions are found for
that currency and type. Note that the portfolio index must either be a valid curve
reference index for the selected currency or DEFAULT.
Portfolio Metric
In the Portfolio Metric column, “Price” refers to the price for FX or Equity and
discount factor for Interest. “Rate” refers to the zero-coupon interest rate.
“Curve Volatility” and “Surface Volatility” refer to the volatility of the rate or
price defined in a volatility curve or surface. For example, if the Portfolio Index
is LIBOR, and the type Interest, then Rate or Price refers to the actual LIBOR-
based interest rate curve while Volatility Curve or Surface refers to any LIBOR-
based volatility curves or surfaces.
Scenario Currency
The Scenario Currency is the currency of the scenario index. In most cases, the
Scenario Currency will be the same as the Portfolio Currency, but this is not
necessarily the case. There may be instances in which data and scenario
elements are not available for a particular currency and there are only a few
transactions in that currency. In this type of situation, it may be desirable to use
scenario elements for a similar currency. Because this approach would
underestimate the basis risk between the two currencies, it should be used
cautiously.
Scenario Index
The Scenario Index is the name of an index that may be used in the scenario set.
If the scenario does not contain this particular index name of the right type, the
simulation will try to use another substitution. The simulation searches through
the valid substitutions in order of the priority number. It searches first for
substitutions with low numbers. If there is no other valid substitution for the
same currency, portfolio index and numeraire (metric type) the simulation will
use the default scenario index defined for that currency, type and numeraire. For
FX rates, the scenario index ‘FX’ must always be used.
The list includes all valid scenario index names. This includes any reference
index that can be used for a curve and any scenario indexes created for index
substitutions. To add a new index to this list, type the name in the edit box
below the Scenario Index list box and press the Add button. Note that an index
cannot be used in an ad-hoc scenario if it is not in this list.
B-45
Credit Simulator
Scenario Metric
In the Scenario Metric column, “Price” refers to the price for FX or Equity and
discount factor for Interest. “Rate” refers to the zero-coupon interest rate.
“Curve Volatility” and “Surface Volatility” refer to the volatility of the rate or
price defined in a volatility curve or surface. For example, if the Scenario Index
is LIBOR and the Type is Interest, then Rate or Price refers to the actual LIBOR
based interest rate curve. Volatility Curve or Surface refers to any LIBOR-based
volatility curves or surfaces.
Priority
The Priority determines the order in which the simulation searches for
substitution scenario indices. The search begins with the lowest priority number
for the particular portfolio index, currency, type and price/volatility. The search
continues with increasing priority numbers until a valid scenario index is found.
Deleting a Substitution
To delete one of the substitutions that has been loaded, left-click on the
substitution to select it. Then select the Delete button.
Saving the Substitutions
When running simulations, you may save the substitutions to the data model for
later use. To save the substitutions using the selected name, press the OK
button. Otherwise press the Cancel button.
Deleting A Substitution Index

Group
To delete all the substitutions saved under a particular name, select the name in
from the list in the Index Substitutions section of the Navigation Panel. Right-
click over the name Index Substitutions and select Delete from the pop-up
menu.
Valuation Parameters
When running a simulation, you must first define the valuation parameters.
These parameters provide information about how the transactions are to be
valued in the simulation. Valuation parameters can be saved and re-used for later
simulations. Each set of valuation parameters has a unique name and timestamp
combination. There can be more than one valuation parameters set with the
same name, provided that they have different timestamps.
The parameter name is defined first and then time-stamped versions are created
using that name. This is done to facilitate running standard simulations on
different dates, using valuation parameters with the same name, but different
timestamps (if the volatility and correlation data has changed).
Select the Valuation Parameters section of the Navigation Panel. Then create
Valuation Parameters as follows:
B-46
User’s Guide
1. Create a new Valuation Parameters name 5LJKWFOLFNRQWKHHPSW\

area at the bottom of the Navigation Panel. Select New from the popup
menu. This will invoke the Valuation Parameters Editor with editable Name
and Description fields.
2. Create a new time-stamped instance of an existing Valuation
Parameters name 5LJKWFOLFNRQWKHSDUDPHWHUVQDPHDQGVHOHFWNew
from the popup menu. The Valuation Parameters Editor will allow you to
edit the fields in the bottom portion of the Valuation Parameters (but not the
Name or the Description).
To modify an existing time-stamped valuation parameters, select the appropriate
timestamp, right-click to bring up the menu, and select Edit. The Valuation
Parameters Editor will appear.
Edit the Valuation Parameters Editor. The fields of this window are described
below. Note that either the Name and Description will be editable or all the
other fields will be editable (depending upon what was selected when the editor
was invoked).
Name
This is the name of the Valuation Parameters. It is used, together with the time
stamp, to identify the exact valuation parameters that will be used to run the
B-47
Credit Simulator
simulation. The same name can be used with several valuation parameters only
if they all have different time-stamps.
Description
The Description is used for information purposes only. It is useful for

determining why particular valuation parameters were created and for deciding
which parameters to use for a particular simulation.
Time Stamp
This is the time at which the valuation parameters were created. When a
simulation is run, the parameters with the time-stamp closest to the valuation
date will be used.
Base Currency
This is the base currency in which the simulation will be run. It will become the
base currency for the valuations in the simulation and the exposure sets will be
expressed in this currency.
Association
The Association list box shows the available valuation associations. Valuation
Associations define the pricing models and market data to be used for valuing
transactions of each security type. Select the required association from the list
box.
Index Substitution
An index substitution must be selected. In the simulation, the index substitution

is used to resolve which scenario elements will be applied to different market
data. For more information about index substitutions, see the previous section of
this manual regarding the Index Substitutions area of the Navigation Panel.
Exclude Cash
When the Exclude check box is selected, cash amounts will be excluded from
the mark-to-market values used in the simulations. These cash amounts are the
settlement cash flows associated with a transaction on the valuation date.
For example, if a bond matures on the valuation date of the simulation, the
redemption value would appear as cash. If the bond is not denominated in the
same currency as the VAR being calculated, it would have a significant effect on
the VAR. If the settlement cash flows are being captured through cash accounts
included in the simulation, they would be counted twice. Hence, if valuation
date settlement cash flows are already reflected in the cash balances of the
portfolios, select the Exclude Cash check box.
Use Implied Forward
When scenarios are created for forward periods there are two different
assumptions that can be made about how interest rates and FX rates are expected
to change. The first assumption is that the expected value for rates in the future
is the implied forward rate for that term from today’s curve. In other words, the
B-48
User’s Guide
forward curve predicts expected future rates. If you wish to operate under this
assumption for the simulation, select the Use Implied Forward check box.
The second possible assumption is that expected rates will remain the same (i.e.
that there is no change in the expected interest and FX rates over the period of
the simulation). This is a reasonable assumption when no reliable forecast for
rate changes is available. If you wish to operate under this assumption for the
simulation, do not select the Use Implied Forward check box.
To save the valuation parameters, click on the OK button. Otherwise select the
Cancel button to exit without saving your changes.
Deleting Valuation Parameters
If you wish to delete one of the Valuation Parameters sets, right-click on the
corresponding date-stamp and select Delete from the popup menu.
Simulating Yield Spread Changes

To simulate volatility in yield spreads, follow the steps below:
1. Create a dependent curve. For example, dependent curve Corporate_Bond =
derived curve Government + simple curve Corporate_Spread.
2. Create scenario elements for the spread. If you are using Monte Carlo, add
volatilities (and perhaps correlations) for the spread to the dataset. If you are
using historical simulation, add historical spread data. For ad-hoc scenarios,
add the spread scenario elements by hand.
3. Add an index substitution. The portfolio index should be the reference index
of the spread curve. The scenario index should be the index of the spread
scenario element.
Running a Simulation
To run a simulation, first select the Results bar from the Navigation Panel.
Running a simulation is a three-step process:
1. Create an Exposure Set Template 5LJKWFOLFNRQWKHHPSW\VSDFHLQ
the Navigation Panel and select “New” from the popup menu.
2. Create an Exposure Set 5LJKWFOLFNRQWKHQDPHRIWKH([SRVXUH6HW
Template and again select “New” from the popup menu.
3. Run the Simulation 5LJKWFOLFNRQWKH([SRVXUH6HWGDWHVWDPSDQG
select “Run” from the popup menu.
These steps are discussed in detail below.
The first step in running a simulation is defining the exposure set template. The
exposure set definition (stored as the template) provides information about how
to perform the simulation and how to save the results. Exposure set definitions
can be saved and re-used for later simulations. Exposure set templates are
uniquely identified by a name and a time-stamp combination. There can be more
than one exposure set with the same name, provided that they have different
timestamps. The exposure set name is defined first (along with other details of
B-49
Credit Simulator
the simulation) as part of the template. Then time-stamped versions are created
using that template name. This facilitates the running of standard simulations on
different dates using exposure set definitions with the same name, but different
timestamps (if the data has changed).
Select the Results section of the Navigation Panel. To create a new exposure set
name, right-click on the empty portion of the Navigation Panel. Select New from
the popup menu. This will invoke the Exposure Set Editor. The top panel will be
editable.
To create a new time-stamped instance of an existing name, right-click on the
exposure set name and select New from the popup menu. The Exposure Set
Editor will allow you to edit the fields in the bottom panel, but not the fields in
the top panel.
To modify an existing time-stamped Valuation Parameters set, select the
appropriate time-stamp, right-click to invoke the menu, and select Edit. The
Exposure Set Editor will appear.
Edit the values in the Exposure Set Editor. (The fields of this window are
described below). Note that either the top panel or the bottom panel will be
editable, depending upon which menu item (New or Edit) you selected.
To delete an exposure set, select the corresponding timestamp in the Results
section of the Navigation Panel. Right-click on the timestamp and select Delete
Name
This is the name of the exposure set. It is used (together with the time-stamp) to
identify which exposure set will be used when running a simulation. The same
B-50
User’s Guide
name can be used with several exposure sets if each set has a different time-
stamp.
Description
The Description field is for informational purposes only. It is useful for

determining why a particular exposure set was created and for deciding which
exposure set to use for a particular simulation.
Bank
This is the name of the primary business entity (for which the credit exposure is
measured during the simulation). For the simulation, only trades that have this
entity as one of the counterparties will be selected. The trades’ other
counterparty will be the one to which there is a credit exposure.
Available and Included

Counterparties
The list of Available Counterparties includes all the counterparties defined in the
system. It is not necessary to identify the credit exposure for all of these
counterparties. It may be desirable to measure the exposure to major
counterparties only and to group all the minor counterparties together as ‘other’
counterparties. In the Available Counterparties list, select the counterparties to
which you want to know your exact exposure. Press the >> button to move the
these organizations to the Included Counterparties list.
Valuation Parameters
This is the name of the valuation parameters that will be used for the simulation.
The name and timestamp combination is used to identify the unique valuation
parameters that will be used. The valuation parameters with the name specified
here and the timestamp closest to, but not after, the timestamp of the exposures
set will be selected. Typically, the valuation parameters will be those specified
or modified most recently prior to the date of the simulation run.
Scenario Set
The Scenario Set is the name of the scenario set series used for the simulation.
The name and the timestamp will determine the actual scenario series that is
used. The scenario series will be selected according to the name specified in this
field and the timestamp closest to, but not after, the base valuation date.
Typically, the scenario series will be that generated most recently prior to the
date of the simulation run.
Directory
This is the path of the directory or folder where the files containing the exposure
results will be saved. You can use either a relative path or an absolute path that
includes the full network address. The relative path will be relative to the path
specified with the CREDIT_STORAGE environment variable. For example, if
the CREDIT_STORAGE environment variable is set to C:\CreditSim and the
directory in the exposure set is results_May5, then the results will be stored in
B-51
Credit Simulator
C:\CreditSim\ results_May5. Note that part of the results are stored in the
database and part are stored in files in the directory.
The CREDIT_STORAGE environment variable of every user must point to the
same directory in the network. When a simulation is generated, CS saves the
results data set of the simulation in the directory indicated by the
CREDIT_STORAGE variable. It saves the name of the results data set in the
database. If users have different directories specified by their
CREDIT_STORAGE variables, errors will occur when they try to load
previously generated results sets, either because their CREDIT_STORAGE
variable is pointing to the incorrect directory or, more seriously, because another
user saved a results data set in the wrong directory.
In addition, for environments where multiple operating systems are used, a
utility for accessing directories transparently across operating systems must be
installed (e.g. Samba).
Base Valuation Date
The Base Valuation Date is the date of the first valuation in the simulation. The
base valuation date represents the zero date. For example, if the term of a
particular scenario series is 1 YEAR and the base valuation date is 10 Feb 1998,
then the valuation date for that series will be 10 Feb 1999.
Time Stamp
This is the time at which the exposure set was created. It will be used to
uniquely identify the exposure set definition.
B-52
User’s Guide
Once a time-stamped instance of the appropriate exposure set definition has

been created, the exposure simulation can be run. Right-click on the time-
stamped exposure set from the Results section of the Navigation Panel. Select
Run from the popup menu. The controller will then communicate with the
simulation engines to perform the simulation. The exposure results will be
saved.
Monitoring Simulations
The Server Query utility (described fully in the Menu Commands chapter) is
used to monitor the progress of simulations.
B-53
Credit Simulator
Using the Display

Once a simulation run is complete, the results can be loaded and viewed. There
are several different ways to view the results and each report can be displayed as
either a table or a graph.
The Results section of the Navigation Panel has two sheets with tabs at the
bottom for selection. The first sheet (Results tab) contains a tree with all the
exposure set definitions and saved results sets. The second sheet (Hierarchies
tab) contains the credit hierarchy.
A valid hierarchy is required for analyzing results. A node in the hierarchy must
be selected before results can be displayed.
The results are shown in separate windows in the display area, on the right side
of the application screen. The menus and the icons at the top of the Navigation
Panel can be used to manipulate the results.
After you have run the simulation, proceed with the following steps to analyze
your results. In the Results section of the Navigation Panel:
1. Create a hierarchy 6HOHFWWKH+LHUDUFKLHVWDEULJKWFOLFNLQWKHWDEDQG
choose “New Hierarchy” from the popup menu. Create a hierarchy that
corresponds to the results you wish to view. Insert levels of the hierarchy as
desired by right-clicking on the new hierarchy and selecting “Insert Level”
2. Select the desired hierarchy node ,QWKH+LHUDUFKLHVWDEVHOHFWWKH
node of the hierarchy that corresponds to the results that you wish to
analyze.
3. Select the desired simulation results ,QWKH5HVXOWVWDEFOLFNRQWKH
name and date-stamp of the results set that you wish to view. Then select
one of the four report types. Your simulation results will be displayed in
graphical form. Click on the table icon to view the results in tabular form.
These steps are described in detail below.
Using the Credit Hierarchy

To create a credit hierarchy, select the Hierarchy Tab from the Results section
of the Navigation Panel. Right-click in the Navigation Panel, and select New
Hierarchy from the popup menu. The Hierarchy definition window will appear.
The fields of this window are described below.
B-54
User’s Guide
Name
This name identifies the hierarchy. Any name can be used, but each hierarchy
must have a different name.
Description
The Description field is provided for information purposes only. It is optional.
Exposure Set
This is the name of the exposure set definition for which the hierarchy is valid.
Root Node Name
The Root Node Name is the name of the root or top node in the hierarchy. This
node represents all the exposures in the simulation results.
OK and Cancel buttons
To save the hierarchy definition and create the hierarchy, press the OK button.
Otherwise, press Cancel to exit without saving your changes.
Editing or Deleting an Existing

Hierarchy
To make changes to a hierarchy after it has been defined, right-click on the root
node in the Hierarchy tab. Select Edit Hierarchy from the popup menu. This
will invoke the Hierarchy window (described above). Edit the fields as
appropriate and press OK to save your changes. To delete a hierarchy, right-
click on the root node and select Delete Hierarchy from the popup menu.
Adding Nodes to the Hierarchy
When the hierarchy is first created, it typically has two levels. In this hierarchy,
every netting agreement is a child of the root node. If the simulation was run
with breakout by book or counterparty, each netting agreement is broken out
accordingly. To add nodes, right-click on any part of the hierarchy and select
Insert Level (and either Country, Credit Rating, Industry or Counterparty)
from the popup menu to add a layer to the hierarchy. The layer will be inserted
at the point in the hierarchy that is selected.
B-55
Credit Simulator
Alternatively, if you select Delete Level from the popup menu, the level of the
selected item will be deleted. Selecting Expand All from the popup menu will
show all the nodes of the hierarchy. The Collapse All command will hide the
entire hierarchy except for the root node. The Refresh command updates the
hierarchy with any changes to the data model.
The nodes are related to each other in a parent-child hierarchy. At the top of the
hierarchy, there is one parent. That parent has child nodes and each of the
children has its own child nodes. At the bottom of the tree are the netting
agreements, identified by number. If the simulation was run with breakout by
book or counterparty, each netting agreement would be broken out accordingly.
The nodes between the netting agreements and the root node are used to group
netting agreements for analysis purposes. Since all exposure falls into a netting
agreement (either an actual master agreement or an automatically generated
agreement), then aggregating the exposure of the netting agreements with a
certain property will give the total exposure to that property.
For example, if the exposure is aggregated for all netting agreements where the
counterparty is a German bank, the resulting exposure is the total exposure to
the German banking industry. Note that the netting agreements can only be
aggregated based on properties of the counterparty (i.e. counterparty name,
country, credit level (or rating) and industry classification). All counterparties to
an agreement should be related (in other words, descended from a common
ancestor). When agreements are not broken out by counterparty, the ultimate
ancestor of the counterparties is used to determine the country, credit rating, etc.
If there is more than one ultimate ancestor, one of them will be arbitrarily
chosen.
B-56
User’s Guide
Hierarchy Example
Agreement Number Description
50 Swaps and FRAs with Deutsche bank
51 FX trades with Deutsche bank
60 All trades with Dresdner bank
70 All trades with Daimler Benz
80 All trades with IBM
Using the above agreements, we will illustrate a hierarchy with five levels:
Level 1 Root node
Level 2 Country
Level 3 Industry
Level 4 Counterparty
Level 5 Agreements
Total Exposure
USA Germany
American German
Computers German Autos
Financial
IBM Daimler Benz Dresdner Deutsche
Agreement 80 Agreement 70 Agreement 60 Agreement 50 Agreement 51
Loading a Hierarchy
Once a hierarchy has been defined, it can be loaded and used with any
simulation results for the same exposure set. To load a hierarchy, select the
Hierarchies tab of the Results section of the Navigation Panel. Left-click on the
name of the hierarchy you wish to load.
B-57
Credit Simulator
Deleting a Hierarchy
All hierarchies will remain in the data model until they are deleted. To delete a
hierarchy, you must right-click in the Hierarchy section of the Navigation Panel.
Select Delete from the pop-up menu.
Selecting a Hierarchy Node to

Display
To display an exposure or loss report for a particular node, left-click on the

desired node in the Hierarchy. Then select the Results tab and open the desired
report. The displayed graph or table will reflect the results for the selected node.
Loading Simulation Results for Display

To load simulation results, first click on the Results section of the Navigation
Panel. Select the Results tab and then click on the name of the desired results
set. Next, left-click on the icon beside the name to expand the selection. This
will show all the time-stamped exposure sets with that name. Select the desired
time-stamp, right-click and choose Load Results from the popup menu.
Alternatively, you can double-click on the results set to load it. Note that the
shape of the icon beside the entry in the control panel indicates if it can be
expanded further (i.e. whether or not it has any child nodes). A diamond-shaped
icon indicates that the item can be expanded and a circle shape shows that it
cannot.
Once the results set is loaded, the Navigation Panel will show the available
reports. After selecting a hierarchy node, double-click on the report name to
view it in the display area. This is explained in more detail below. Multiple
report windows can be left open at the same time. Selecting the bar at the top of
a report window will bring it to the top. You can also use the main menu item
Window to arrange the report windows in the display area. For example, the
Window: Tile command will arrange the windows horizontally across the
display area so that each window is the same size.
B-58
User’s Guide
Two tiled exposure reports and the Navigation Panel popup menu
Viewing Simulation Results
Select the Hierarchy tab from the Results section of the Navigation Panel. Left-
click on the hierarchy you want to use for analyzing the simulation results. To
view the individual hierarchy, right-click on the hierarchy and select Expand
All or double-click on the node for which you would like to see children. Select
the node from the hierarchy for which you would like to view a report.
Select the Results tab and then select the name of the desired exposure set. It
will expand to show the various time-stamped instances for that name. Select the
desired time-stamp. Right-click and select Load Results from the popup menu.
Alternatively, you can double-click on the timestamp. The results set will be
loaded. This may take a few minutes, depending upon the size. If you are not
sure which exposure set to select, you can right-click on any of them and select
Edit to view the exposure set definition. When the simulation results are loaded,
the reports available will be displayed in the Results tab of the Navigation Panel.
The available report types are Credit Exposure, Credit Losses, Scenario
Exposure and Scenario Losses. Double-click on the desired report type. The
report for the selected hierarchy node will be shown in a window in the display
area.
B-59
Credit Simulator
Credit Exposure
The Credit Exposure report view shows the expected and maximum exposure
for the selected hierarchy node over the time period of the simulation. The
expected exposure (Mean) at any time point is the average exposure across all
the scenarios for that time period. The Maximum is the highest exposure across
the scenarios for 95% of the cases. For example, if 200 scenario paths were used
for the simulation, then the maximum exposure would be the 10th highest
exposure for each time period. To view the Credit Exposure report, click on the
Credit Exposure report type in the Results tab.
NOTE: If clicking on the Credit Exposure node does not produce a meaningful
graph, possible causes include the following:
(1) The selected Portfolio does not contain the same counterparties or securities
as the selected Scenario Set (e.g. the portfolio contains bonds and the
scenario set handles swaps).
(2) The hierarchy node you have selected in the Hierarchies tab does not
correspond with the results set you are attempting to view.
B-60
User’s Guide
Exposure Frequency
To view the frequency distribution of exposures at a particular time period,

double-click on the Credit Exposure graph at the desired time period. The
exposure distribution graph will be invoked.
Credit Losses
The Credit Losses view shows the expected and maximum credit losses for the
hierarchy node selected. These losses are calculated from the exposures (using
the expected default probabilities and recovery rates for the specific credit
levels). More specifically:
Credit Losses = (Credit Exposures) (Default Probabilities) (1- Recovery Rate)

To view the Credit Losses report, click on the Credit Losses report type in the
Results tab. Double-click on a particular time period to view a loss distribution
graph for that period.
NOTE: If you are examining the potential credit losses associated with a
counterparty whose default probability for a particular time horizon is zero, there
will be no credit losses to graph. For example, if a counterparty has the “AAA”
credit rating and the default probability associated with that credit rating is
.00000 for 1YEAR, then Credit Losses = (Credit Exposures) 0 (1 - Recovery
Rate).
B-61
Credit Simulator
Scenario Exposure
The Scenario Exposure report view shows the exposure under each scenario for
the selected hierarchy node. The exposures for each scenario path are shown as a
red line. If there are 200 scenario paths used in the simulation, there will be 200
lines in the graph. If there is a large number of scenario paths, it may difficult to
identify individual exposures. However, this report is still useful for showing
how the exposures change over time for the extreme scenario paths. To view the
Scenario Exposure report, click on the Scenario Exposure report type in the
Results tab.
Double-click on a particular time period in the scenario exposures graph to
invoke a plot showing the exposures under each scenario for that time period.
B-62
User’s Guide
The exposure for each scenario is shown as a single bar. The scenario numbers
are those shown in the Scenario Set Series editor. Since the scenarios are
generated randomly, the order of the scenarios has no significance. Note that if
the cursor is place at the top of the bar, the exact value of the exposure will be
shown in a tooltips type label. This applies to all the graphs.
Scenario Losses
This Scenario Losses graph shows the expected losses under each scenario. The
expected losses are calculated using the default probability and recovery rate for
each credit level. More specifically:
Scenario Loss = Scenario Exposure (Default Probability) (1- Recovery Rate)
Double-clicking on a particular date will bring up a bar graph showing the
expected loss under each scenario for that time period.
Display as Table
All reports can be displayed in Table format as well as Graph format. Select a
report graph to re-format by clicking on the bar at the top of the report. Then
click on the Table View icon at the top left of the main window. Alternatively,
you can use the View: Grid menu command to alter the format. The report will
be displayed in Table view (as shown below).
To return the report to Graph format, either click on the Graph View icon or
select the View: Graph menu command.
Printing
All reports can be printed (in either Graph or Table format). Select the report
you wish to print by clicking on the bar at the top of the report window. Then
click on the Print Preview icon or select the File: Print Preview menu
B-63
Credit Simulator
command. The preview will be displayed in the window. You can zoom in or
out and move between the different pages of the printed report by using the
command buttons above the preview.
When you are satisfied with the report, click on the Print button or select the
File: Print menu command. By printing, you will return to the normal view.
Alternatively, select the Close button to return to the normal view without
printing.
Print Setup
To change the print setup, select the File: Print Setup command. This will
invoke the Print window.
In this window, you can select the printer, the pages to be printed, and the
number of copies.
B-64
User’s Guide
Copy and Paste
All reports can be copied to the Windows clipboard and then pasted into other
applications. To execute these actions, use the Copy icons (or Edit menu
commands). The Copy-All icon will copy the currently selected graph or table.
The Copy-Selection icon will only copy the currently selected cell in a table
report.
For example, the data from a table can be copied and then pasted into a
Microsoft Excel spreadsheet. Select a Table View report and click on the Copy
All icon (or select the Edit: Copy All menu command). Then open Excel and
create a new workbook. Select Edit: Paste from the Excel menu. The result is
shown below.
Creating Reports
It is also possible to save the report data to a text file so that it can be used by
other applications. To save to a text file, select the desired report view from the
Results section of the Navigation Panel, right-click and choosing Create Report
from the popup menu. A dialog box will appear with two options Detailed
and Summary.
The Detailed report will save the expected and maximum exposures or losses for
each time period for each hierarchy node. The Summary report will save the
average expected and the peak maximum exposure or loss. These reports are
useful for integrating the data from Credit Simulator with other applications
such as Limit Manager or custom report writers.
B-65
Credit Simulator
Changing the Netting
It is possible to change the netting assumptions for a particular report. Right-

click on the report and select the desired netting rule from the popup menu.
Then double-click to open the report. The report will be created using the
netting rule selected. This is useful for testing the impact of netting as well as for
measuring the legal risk of netting agreements that are not enforceable in a
particular jurisdiction.
Refreshing the Results
Results data may have changed since the application was started and the data
shown in the Results tab of the Navigation Panel may not be up-to-date. For
example, a simulation run may have completed or another user may have added
an exposure set. To update the display, right-click on the Results section and
select Refresh from the popup menu. This can also be used to refresh a
particular report if new trades have been added to the results.
Saving Results to a File
If you wish to save a report as a *.csv file (for use in an Excel document), select
the File: Save As menu command. You will be prompted to indicate the
directory in which the file should be saved.
Closing the Report
To close the currently selected report results graph or table, select the File:
Close menu command.
Deleting Simulation Results

To avoid using excessive space in the database and file system, it may be
desirable to delete simulation results that are no longer needed. In the Results
tab of the Navigation Panel, left-click on the results you wish to delete. Then
right-click to bring up the pop-up menu and select Delete. You will be prompted
to confirm the deletion. Click on the OK button to confirm. Click on the Cancel
button to close the window without deleting any results.
Exiting the Application

To exit the Credit Simulator application, select the File: Exit menu command.
B-66
User’s Guide
Chapter 6 Menu Commands
In Credit Simulator’s main window, the following menu commands are located
under the File menu:
• Close (see page B-66)
• Save As (see page B-66)
• Print (see page B-63)
• Print Preview (see page B-63)
• Print Setup (see page B-64)
• Exit (see page B-66)
The following menu commands are located under the Edit menu in the main
window of Credit Simulator:
• Copy (see page B-65)
• Copy All (see page B-65)
The View menu in the main window of Credit Simulator contains the following
commands:
• Grid (see page B-63)
• Graph (see page B-63)
• Control Panel (see page B-78)
• Output Panel (see page B-78)
• Toolbar (see page B-78)
• Status Bar (see page B-78)
In Credit Simulator’s main window, the following menu commands are located
under the Settings menu:
• Global Settings (see page B-68)
• Exposure Settings (see page B-68)
• Credit Levels (see page B-70)
• Credit Data (see page B-72)
• Import Dataset (see page B-73)
B-67
Credit Simulator
• View Dataset (see page B-73)

• Server Query (see page B-76)
For more information about these menu commands, please see the
corresponding section of this chapter.
Credit Simulator’s Window menu contains the following commands:
• New Window (see page B-79)
• Cascade (see page B-79)
• Tile (see page B-58)
• Arrange Icons (see page B-79)
Under the Windows menu, you will also find a listing of open report windows.
You can toggle between the report windows by selecting the report that you
wish to bring to the foreground.
Credit Simulator’s Help menu contains one command:
• About Credit Simulator
This command will invoke a window that indicates the version of Credit
Simulator you are currently running.
Global Settings
The Global Settings window allows you to specify the FX quotation base
currency (i.e. the currency in terms of which all other currencies are quoted). If
CS and Market Simulator are being run off the same database, this setting will
apply to both applications.
The Global Settings window is invoked by the Settings: Global Settings menu
command.
B-68
User’s Guide
Exposure Settings
There are several options that can be set by the user to determine the specific
behavior of certain functions of Credit Simulator. These are accessed from the
main menu by selecting the Settings: Exposure Settings menu command.
This will invoke the Exposure Settings dialog box.
These settings apply to all exposure simulations performed with Credit

Simulator. Apart from the breakout settings, these settings are provided for
system administration purposes and should not be changed by the user.
Engine Hosts
The Engine Hosts list box contains a list of machine host names that will be
used for running simulations. The simulation valuation can be performed as
multiple, parallel processes on several different machines at the same time. A
valid engine host list must be specified and each host must be correctly
configured.
If you wish to run more than one process on a particular host, enter the host
name multiple times in the list. Use the Add Host and Remove Host buttons to
modify the list as required.
Controller Host
The Controller Host is the host name of the machine on which the simulation
controller will run. The controller is a separate process that monitors and
allocates tasks to the simulation engines.
Filter Portfolio
The Filter Portfolio list box contains the portfolio definition used to limit the
scope of the simulation. Only trade legs that fall into the filtered portfolio will be
B-69
Credit Simulator
included in the simulations. For example, the filter portfolio can be used to limit
the simulations to trades with Trade Status of “Booked” only.
Bank Breakout
The Bank Breakout setting determines if and how the bank’s exposure will be
broken out according to the organizational units within the bank. The following
three choices are available:
• 1RQH Selecting “None” will create exposure results that treat the bank as
a single unit. From these results, it will not be possible to identify which
parts of the bank are responsible for particular credit exposures.
• %\&RXQWHUSDUW\ Choose the “By Counterparty” selection to break
down the exposure results by the counterparty representing the bank. This is
useful if a bank uses different internal counterparties to distinguish between
different business units or legally distinct parts of the bank. It will be
possible to determine the credit exposures corresponding with each
individual internal counterparty. Note: Even though the exposures are
broken down by internal counterparties, the results only include trades
performed with external counterparties (i.e. trades between internal
counterparties do not generate credit exposures).
• %\%RRN The “By Book” selection breaks down the exposure results by
book.
Counterparty Breakout
The Counterparty Breakout radio buttons turn on or off the breakout of exposure
by external counterparty. If “None” is chosen, it will not be possible to identify
the actual counterparties to which the bank is exposed; only aggregated exposure
results will be available from the simulation.
Default Random Seed
The Monte Carlo scenario generation uses a seed value to generate pseudo-
random numbers. The user can set the seed when generating the scenarios. If the
user does not enter a new seed, the default seed will be used. If the same seed
value is set, Monte Carlo scenarios generated will be identical when the input
parameters are the same. If a different seed is used, scenario sets and simulation
results will differ slightly even if all the other inputs are identical.
The other settings relate to performance tuning for the distributed simulation
calculations. Only a system administrator should change these settings.
Credit Level Data

To edit credit level data, select Settings: Credit Levels from the main menu.
The Credit Level dialog box will appear. Enter the data as required and select
the OK button to save the changes or Cancel to discard them.
B-70
User’s Guide
The credit levels are ordered by credit quality, with Rank “1” being the highest
quality (i.e. lowest likelihood of default). Press the New button to create a new
credit level. This will invoke the New Credit Level window. The fields of this
window are described below.
Select the Move Up and Move Down buttons to change the priority of the
selected level. The Delete button will remove the selected level.
Rank
The Rank is a sequential number indicating the relative quality of the credit
level. The lowest rank corresponds to the highest credit quality (and vice versa).
This field is not editable. To change the rank of a particular credit level, select
that level and use the Move Up and Move Down buttons until the level reflects
the desired rank.
Name
This is the name used to identify the credit level. It will be used to group
exposures by credit quality and to find the appropriate default probability for a
particular exposure.
B-71
Credit Simulator
Description
The Description field is provided for information purposes only. It is an optional

field.
Default and Recovery Data

Credit Simulator needs default and recovery data to calculate expected losses.
To edit this data, select the Settings: Credit Data menu command. This will
invoke the Credit Level Data dialog box.
For every credit level defined in the system, there must be a recovery rate and
default rates for different periods or tenors.
Recovery Rate
The recovery rate is the proportion of the outstanding net obligation that is
expected to be recovered if a counterparty defaults. For example, if the recovery
rate for credit level “A” is 0.5, this indicates that if a counterparty with credit
level “A” were to default, on average we would expect to recover 50% of what
they owed. This recovery rate should take into account the seniority of the
obligations held by the bank.
Default Probability
The value in the cells of the table represents the expected default probability for
the counterparties with the respective credit levels. The data represents the
cumulative probability of default over time. For example, a cumulative default
probability of 0.068 for 1 year for a B credit, indicates that there is 6.8%
likelihood of the B credit counterparty defaulting on its obligations within a
year. A “0.131” cumulative default probability for 2 years means that there is a
13.1% likelihood of default within two years. This implies that the marginal
B-72
User’s Guide
default probability (the likelihood of default in the second year only) is:
(1 - .068) (1 - x) = (1 - .131) or 6.76%.
Press the Insert Tenor button to add a new time period (i.e. a new column).
Select the Clear Level button to empty the data in the current row.
Fill in the recovery rates and default probabilities and click on the OK button to
save them. Press Cancel to discard your changes and exit the window.
Importing Volatility and Correlation Datasets

One source of volatility and correlation data is the RiskMetrics dataset from J. P.
Morgan. This is provided at no cost by the RiskMetrics’s internet site.
Downloading the data can take a long time (approximately an hour) because the
amount of data is significant. The data can be downloaded via the world wide
web using a web browser. It may be preferable to have this done automatically
every day. Ask your system administrator for help with automating this process.
Once the data files have been obtained, they are loaded into the data model
using the Settings: Import Dataset main menu selection. Users can specify the
currency of the RiskMetrics dataset.
Appendix 1 explains how to create user-defined data files and other data-related
tasks.
Viewing Correlation and Volatility Datasets

From the main menu select Settings and then choose the View Dataset...
command. This will invoke the Dataset window. Select the Volatilities and
Correlations dataset you would like to view.
Dataset Date
Select the date of the dataset that you would like to view. This is the date on
which the data was generated. The data includes closing prices for markets on
that day. Typically, the data becomes available the day after it is generated.
B-73
Credit Simulator
Dataset Name
Select the dataset you want to view. You can choose between the following
datasets:
• RiskMetrics The RiskMetrics dataset is provided daily by J. P. Morgan.
It offers daily and monthly volatility and correlation estimates for exchange
rates and interest rates of 23 currencies. The interest rate data is provided for
money markets (six points), swap zero rates and government bond zero rates
going out to 30 years. The volatilities and correlations are calculated from
historical daily data, using exponential decay weighting.
• BIS This is the RiskMetrics regulatory dataset provided by J. P. Morgan.
It covers the same data as the daily dataset, but is estimated using one year
of historical data with equal weighting. The other RiskMetrics datasets use
exponential decay weighting. This dataset can be used to evaluate the
‘internal models’ approach of the BIS Committee. The internal model
specification requires equally weighted one-year historical estimates, with a
10-day holding period and 99% confidence.
• Other It is possible to import other datasets into the data model and use
them for simulations. These are defined by the user and can have any name.
Dataset Horizon
The Dataset Horizon is the time period for which the volatilities and correlations
apply. For example, a 1DAY time horizon means that the volatilities refer to the
volatility of one-day price movements.
Select the desired dataset and click on the OK button. Otherwise press the
Cancel button to return to the main window.
If you select the OK button, the volatilities and correlations View Dataset
window will appear.
B-74
User’s Guide
Currency 1 and Currency 2
These list boxes contain all of the currencies in the chosen dataset. Select one
currency from each list box. Since the datasets are typically very large it is not
practical to view them in their entirety at once. A particular portion of the
dataset can be viewed by selecting the required currencies. If two different
currencies are selected as Currency 1 and Currency 2, the correlations between
the various factors of those currencies will be displayed. If the same currency is
chosen in both list boxes, the correlation between the different factors of that
currency will be displayed.
Base Currency
The volatility and correlation datasets can be viewed with different base
currencies. The base currency is that currency in which the exchange will be
expressed. The FX volatilities and correlations will be calculated for the base
currency chosen.
For example, assume a dataset is viewed with the base currency set to DEM. In
this case, a GBP FX factor volatility will refer to the volatility of the GBP/DEM
rate. The foreign exchange volatilities and correlations will be adjusted so that
they reflect cross rates between DEM and the other currencies. For instance, the
DEM volatility will be zero because the DEM/DEM FX rate is always “1.”
Similarly, the correlation between DEM FX rates and any other factor will be
zero; since the DEM FX rate does not change with respect to the DEM currency,
it does not yield any useful correlation information.
Volatilities
B-75
Credit Simulator
The Price and Yield volatilities shown are for a 95% confidence interval (i.e.,
1.65 times the standard deviation of returns for the chosen time horizon).
Server Query
The Credit Simulation Server can be controlled and monitored from the Credit
Simulator application using the Server Query function. This is accessed from the
main menu by selecting Settings: Server Query.
This will invoke the Server Query dialog box.
Starting/Stopping the Server
The Start/Stop portion of the window displays and controls whether the
simulation server is running. To start the server, click on the Start Server button.
Starting the server will block the application for several seconds; the length of
this interval is specified in the settings. If the button is disabled, the server is
already running.
To stop the server, click on the Stop Server button. If the button is disabled, the
server is already stopped.
B-76
User’s Guide
Under some circumstances, the server may cease to respond to queries from
Credit Simulator. In this case, the server must be stopped by the operating
system. To do this on Windows NT, right-click on the task bar and select Task
Manager from the pop-up menu. Select the server (called "Controller") in the
Task Manager and click on the End Process button. This procedure can also be
followed to stop runaway Credit Simulator engines. Under normal
circumstances, when the server stops, it should stop the engines.
Simulation Information
The Simulations section displays the simulations in progress and can be used to
display the status of a particular simulation. The simulations in progress are
displayed in the list box. If the list box is empty, no simulations are running. To
see more information about a simulation, double-click on the simulation item in
the list box. The degree of completion, type of work being performed, and error
status of the simulation are displayed.
The amount of work is measured in "netting units," abbreviated “NU’s.” A
netting unit is a subdivision of a netting agreement and can vary widely as to the
number of trades it contains and the computational difficulty of those trades. As
a result, netting units are only a rough indicator of the amount of work. Also,
engines work on more than one netting unit simultaneously and do not indicate
how far they have progressed through a batch. Consequently, the numbers in
the NU status boxes will jump. The number of netting units per batch is
specified in the settings.
Stop Simulation
To stop a simulation in progress, click on the Stop Simulation button. This will
stop all engines working on the simulation. The exposure for netting units that
have already been processed will be saved in the exposure set, but work in
progress on the engines will be lost.
NUs Done
The NUs Done field gives the number of netting units that the simulation has
already processed. Netting units are used internally to organize trades. A netting
unit is typically equivalent to the number of trade legs falling under a single
netting agreement.
NUs In Progress
The NUs In Progress field gives the number of netting units currently under
simulation.
NUs To Be Done
The NUs To Be Done field gives the number of netting units that the simulation
has not yet started to process.
NUs Failed
The NUs Failed item gives the number of netting units for which an error
occurred during simulation.
B-77
Credit Simulator
Status
The Status edit box shows the current simulation status. There are three possible
status messages: Mapping Trades, Getting Netting Units, and Simulating.
• Mapping Trades This is the process of assigning trades to netting units.
A Re-map means that all trades in the filter portfolio are assigned; an
Update means that only new, unassigned trades are assigned. This process is
relatively short compared to actual simulation.
• Getting Netting Units This is the process of collecting the netting units
to be used for simulation. Again, this process is relatively short compared to
actual simulation.
• Simulating This is the process of actually performing a full-valuation
exposure simulation. A Base simulation recalculates the exposure of all
trades in each netting unit. An Update computes exposure only for new
trades not yet reflected in the exposure set.
Last Message
The Last Message edit box shows the last error message issued against the
selected simulation, if any.
Engines
The Engines section shows which engine hosts are in use for any simulation, and
the status of each engine. The status should normally be “Working.”
Done
When you are finished monitoring simulations, you can dismiss the Server
Query dialog by clicking the Done button.
View Menu Options

The View menu commands allow you to decide whether the Credit Simulator’s
Control Panel, Output Panel, Toolbar, and Status Bar are displayed.
B-78
User’s Guide
Status Bar Control Panel Toolbar Output Panel

When a check appears next to one of these four menu commands, the
corresponding panel or bar will appear in the display. To hide a panel or bar,
simply select the appropriate menu command. The check next to that item will
disappear from the menu and, simultaneously, the panel or bar will disappear
from the application screen.
Window Menu Options

The Window menu options include: New Window, Cascade, and Arrange Icons.
By selecting the Window: New Window command, you will invoke a new
report window identical to the currently selected report window. You can
manipulate the display of each copy of the window separately. In other words,
you can display the report as a graph and a table simultaneously.
Selecting the Window: Cascade menu command will organize the open report
windows so that the title bar of each window is visible.
The Window: Arrange Icons menu command will reorder the minimized
document windows in alphabetical order according to the document titles.
B-79
Credit Simulator
B-80
User’s Guide
Part C
METHODOLOGY
C-81
Credit Simulator
C-82
User’s Guide
Chapter 7 Simulation Basics
Exposure Calculation Overview

Credit Simulator measures future credit exposure by estimating the replacement
cost of each transaction over the life of the portfolio. It includes effects of close-
out netting by grouping trades that can be netted together. It provides detailed
analysis of the resulting exposure as well as exposure aggregated by
counterparty, country, industry classification, and credit rating.
Calculation Steps
The basic steps of the calculation are:

1. Generating Scenarios
• Produces scenario paths going forward in time. (A scenario is a set of
hypothetical assumptions about the future).
2. Running Exposure Simulation
• Each transaction is valued for each scenario at different points in the
future (using standard mark-to-market routines).
• Transaction exposure is aggregated according to netting agreements.
• Netting agreement exposures are saved to the data model. The sum of
the positive and sum of negative mark-to-market values are saved for
each netting agreement.
3. Analyzing Results
• Netting unit exposures are aggregated by counterparty, industry,
country, etc. using a user-defined credit hierarchy.
• Multiple hierarchies can be applied to a single simulation result to
perform different aggregations.
• The effects of netting can be modeled interactively.
Generating Scenarios
Scenarios are created with specified price volatilities and correlations. The
volatilities and correlations can be obtained from several sources, including J. P.
Morgan’s RiskMetrics. The scenarios are grouped together in scenario series,
representing multiple paths over the time horizon of the simulation. Each path
C-83
Credit Simulator
will have scenarios at specific periods. The user selects these time periods. In
addition to matching the desired volatilities and correlations, the process used to
generate the interest rate scenarios also meets the following requirements:
• the interest rate process is arbitrage-free (the user may override this
assumption)
• interest rates are mean-reverting
• interest rates are lognormally distributed and cannot be negative
• the parameters required (volatilities, correlations and mean-reversion

speeds) are readily available and there are no calibration problems
Credit Simulator uses an improved Monte Carlo method based on stratified
sampling. In the standard Monte Carlo, rate changes are sampled randomly from
independent normal distributions. The rate changes are then adjusted to reflect
the desired correlations. In the stratified sampling method, the distributions of
price changes are divided into sections. Each section is sampled only once. This
greatly improves accuracy and reduces the number of scenarios required for
accurate results.
Running Simulations
Credit Simulator uses an advanced distributed processing architecture to achieve

scalable performance (even with large portfolios). Using incremental updating, it
is possible to perform near real-time exposure calculations and pre-deal
exposure checks. The majority of the exposures are calculated periodically (e.g.
daily) from the beginning, rather than merely updating previous exposure
calculations. Intra-day incremental updates are also made to the results as trades
are entered. In this way, the exposures are kept current. It is possible to update
one set of results while simultaneously calculating a new set. Both calculations
can be performed with multiple processes and multiple computers.
Exposure Example
A bank has five trades with Counterparty ABC. Three of these trades (01 to 03)
fall under a close-out netting agreement (Agreement A). Trades 04 and 05 are
not nettable and fall under Agreement B.
Scenarios
We create scenario paths with 5 periods each. The periods fall at 1 month, 6
months, 1 year, 2 years and 3 years. The factor changes in the scenario paths are
consistent with the volatility and correlation data and the mean-reversion
parameters used to generate them.
C-84
User’s Guide
Exposure Calculation
The NPV of each transaction is calculated for each period.
NPV on scenario date, for market rates of first path

Path Agreement Trade 1 month 6 months 1 year 2 years 3 years
1 A 01 10 50 100 40 5
02 10 -10 5 10
03 -5 -10 -30 -15
B 04 5 7 9 3
05 -15 -20 8
For each agreement, the sum of the positive and the sum of the negative NPV’s
of a particular scenario path are stored for each time horizon. This is the Raw
Exposure.
Raw Exposure
Path Agreement + /- 1 month 6 months 1 year 2 years 3 years
1 A POSITIVE 20 50 105 50 5
NEGATIVE -5 -20 -30 -15 0
B POSITIVE 5 7 17 3 0
NEGATIVE -15 -20 0 0 0
The credit exposure for each of the aggregation units is calculated by adding the
positive and negative NPV’s for nettable aggregation units and taking the sum of
the positive NPV’s for non-nettable aggregation units.
Credit Exposure
Path Agreement Nettable 1 month 6 months 1 year 2 years 3 years
1 A YES 15 30 75 35 5
B NO 5 7 17 3 0
If we are interested in the exposure to Counterparty ABC, we need to aggregate

the exposures for Agreements A and B. This aggregation cannot be netted. As a
result, only the positive exposures are added together. Negative exposures are
treated as zero.
Credit Exposure Counterparty ABC
Path 1 month 6 months 1 year 2 years 3 years

1 20 37 92 38 5
C-85
Credit Simulator
The same is done for the other scenario paths:
Credit Exposure Counterparty ABC

Path 1 month 6 months 1 year 2 years 3 years
1 20 37 92 38 5
2 10 30 53 24 2
3 2 0 0 3 1
4 ……
Then the average and the 95% confidence worst-case scenario across all (for
example, 200) scenarios is calculated:
Exposure - counterparty ABC 1 month 6 months 1 year 2 years 3 years

Average: 10 25 27 20 2
95% highest: 20 35 70 33 5
The average across all the paths gives the expected exposure. The x-percentile
highest across all the paths gives the worst-case or maximum exposure.
Loss Calculations
The exposure for each agreement is multiplied by the default probability and by
the loss proportion (1 - the recovery rate) for the particular credit level of the
counterparty. This gives the expected loss based on the exposure. The average
across all the paths gives the expected loss. The 95-percentile highest across all
the paths gives the worst-case or maximum loss.
The Interest Rate Process

The interest rate process used in Credit Simulator is a multi-factor, mean-
reverting, lognormal process with a drift term that can be chosen to use or to
ignore the implied forward curves.
Multi-factor process
Pricing models for interest rate options often make use of interest rate processes
with just one or two factors. With a one-factor process, such as the original Hull-
White process, the stochastic changes to a yield curve are determined by a single
stochastic factor, the short rate. Although the rates corresponding to different
terms can have different volatilities, the changes to the rates are perfectly
correlated. The volatilities for the different rates cannot be chosen
independently, since the whole volatility curve is usually determined by two free
parameters—the short rate volatility and the mean reversion parameter. With a
two-factor process there are two stochastic factors, which give more freedom for
fitting volatility curves, although the possible changes to the yield curve are still
quite restrictive.
C-86
User’s Guide
Credit Simulator does not use a one-factor or two-factor process. It uses a multi-
factor process, with as many factors as there are volatilities in the volatility and
correlation dataset. There are no calibration problems as exist in a multi-factor
pricing model because the volatilities are chosen to be historical volatilities
(rather than being fitted to match prices of interest rate options).
Thus, each rate in the yield curve follows a stochastic process of the type
dri = σ i ⋅ ri ⋅ dzi + K ,
where σ i is the volatility for the rate ri , and the K denotes the missing drift
term (whose form depends on whether the rates drift towards their implied
forward values). The rates are correlated according to the correlation matrix. The
process is guaranteed to match the initial yield curve and the initial historical
volatility curve.
One comment should be made about the volatility and correlation dataset. If the
RiskMetrics datasets are used for long-term simulations, the monthly datasets
are a better choice than the daily datasets, since the monthly correlations are
more stable than the daily correlations.
Implied forwards
Credit Simulator allows the user to choose whether or not to use implied forward
rates for the stochastic generation of future interest rates and FX rates. If the
implied forwards are used, the mean value of each future interest rate and FX
rate will be the forward rate derived from today’s yield curve and spot FX rate.
If the implied forwards are not chosen, the mean value of each future interest
rate and FX rate will be the current day’s rate. Arguments can be made in favor
of either of these choices.
When pricing derivatives, the use of implied forward rates is mandatory. The
price of a forward currency contract, for example, must be computed by
assuming that the expected future FX rate is the forward rate derived from
today’s spot rate and today’s yield curves; any other choice would lead to an
arbitrage opportunity. The same is true for swaps, forward rate agreements, and
all other such derivatives.
But, it is not essential to use implied forward rates when generating scenarios in
a risk-management simulation. This is a source of frequent confusion. It is often
incorrectly stated that a simulation is not arbitrage-free if it does not use the
implied forward rates. In point of fact, an arbitrage opportunity allows an
individual to make a risk-free profit. If one uses today’s rates (or some other
rates different from the implied forward rates) as the expected future rates in a
risk-management simulation, that does not lead to an arbitrage opportunity.
The assumption that today’s forward rates correctly predict the expected future
rates is known as the Expectations Hypothesis. (The alternative assumption, that
today’s spot rates correctly predict the expected future rates, is known as the
Risk Premium Hypothesis). Considerable evidence suggests that the pure
Expectations Hypothesis is invalid. Yield curves are usually upward sloping,
producing forward rates that are higher than today’s rates. Yet rates go down as
often as they go up. A recent paper on the subject states:
Overall, the empirical evidence is more consistent with the risk premium
hypothesis than with the pure expectations hypothesis. Forwards tell us more
C-87
Credit Simulator
about near-term expected return differentials across bonds than about future rate
changes. If either today’s spot curve or the implied spot curve one period
forward must be used as a predictor of the next period’s spot curve, the evidence
1
supports the use of the former as the neutral base case.
The evidence from data on FX rates is similar. There are many papers in the
economics literature on the “forward premium anomaly”—the fact that FX rates
often move opposite to the direction predicted by the implied forward rate.
There is one argument that can be made for using implied forward rates.
Suppose one enters a forward FX contract today and then runs a simulation to
predict future credit exposures. If the implied forward rates are used in the
simulation, the expected exposure will not depend on which side of the contract
one has taken. But, if the implied forward rates are not used, one side will lead
to a larger exposure than the other. Many people view this effect as undesirable.
Neither the pure Expectations Hypothesis nor the pure Risk Premium
Hypothesis is correct; the truth is a mixture of the two. In practice, the choice of
one or the other should not make much of a difference in a credit-risk simulation
over short time scales.
Mean reversion
Mean reversion rates are necessary if a risk-management simulation is to

generate reasonable yield curves at dates far in the future. (Credit Simulator uses
mean reversion only for interest rates; it is not used for other risk factors). To
understand the importance of mean reversion rates, imagine performing a long-
term simulation with an interest rate process like that used in the RiskMetrics
market risk methodology. In this methodology, each risk factor S is assumed to
follow a stochastic equation of the type
dS = σ ⋅ S ⋅ dz ,
where dS is the stochastic increment to S in a short time dt , dz is the
increment to a standard Normal random variable in the same time, and σ is the
volatility. 2 The drift term is ignored, since it is not important for the short time
horizons typically used in market risk simulations. After a time t , the factor S
will be distributed according to a lognormal distribution with a variance equal to
σ 2t , giving a standard deviation equal to σ t , which grows proportional to
the square root of the time. This can become unreasonable if a simulation is
extended far into the future: the standard deviation can grow to be much too
large.
A simple way to reduce the growth is to add a drift term
dS = − a ⋅ S ⋅ dt + σ ⋅ S ⋅ dz ,
1
A. Ilmanen, “Market rate expectations and forward rates”, J. of Fixed Income,
pp. 8–22, Sep 1996.
2
In the RiskMetrics methodology, the risk factor used in the yield curve
simulations is the discount factor (not the interest rate). This difference is not
important for the discussion of mean reversion given here.
C-88
User’s Guide
where a is the mean reversion rate. The “mean” in this example is zero, since if
S becomes positive the drift term pushes it back down and if S becomes
negative the drift term pushes it back up. The variance of the lognormal
distribution of S ( t ) is now
 1 − e −2at   2 
σ 2  ≈ σ ⋅ t ⋅ 1 − at + ( at ) − K .
2 2
 2a   3 
When t is small, the variance grows linearly with time (just as it would without
mean reversion), but when t is large, the variance gets capped at a maximum
value σ 2 2a .
Mean reversion is implemented in Credit Simulator as follows: Each interest
rate is assumed to follow a stochastic process like that given above for S .
However, unlike the process described above, for the interest rates, the mean
reversion pushes the rates towards their expected future values. The future
value may be either today’s rate or the implied forward rate, depending on
whether the user has selected ‘Use Implied Forwards.’ There is one mean
reversion parameter per currency (i.e., all the rates in a given currency use the
same mean reversion rate).
How should the mean reversion rate for a given currency be chosen? Different
answers to this question might be produced for a risk-management simulation
than for calibration of a pricing model. When a pricing model (like the Hull-
White model) is used to price interest rate options, you must select the mean
reversion rate so that the model provides the best fit for all market prices. The
fitted mean reversion rate can be thought of as an implied mean reversion rate,
since it is implied by the option prices. The fitted rate may be close to a
historical mean reversion rate, but this is not guaranteed; in some cases the fitted
rate will be negative, corresponding to mean aversion, not mean reversion.
For a risk management simulation, the mean reversion rate that generates future
yield curves need not be the same as the mean reversion rate used in the pricing
models. This is true for the same reason that the volatilities used in a risk-
management simulation (normally historical volatilities) need not be the same as
the implied volatilities used in the pricing models.
Unfortunately, it is not as easy to find data for historical mean reversion rates as
it is for historical volatilities. If such data is not available, you have two options.
The first option is to calibrate the mean reversion rate by choosing it so that the
variance formula on the previous page gives a reasonable fit to the volatilities
(squared) from a cap curve. This will be an implied mean reversion rate, but it
should be acceptable as long as the cap volatilities are decreasing with time (as
is normally the case). In other words, calibrating the mean reversion rate will be
effective so long as the implied mean reversion is positive.
When historical mean reversion rates are not available, the second option is to
simply choose the mean reversion rate so that the long-term volatility σ 2a
does not exceed a certain desired maximum value. The following example
illustrates this option: Suppose that the volatility σ for a rate in the simulation
corresponds to an annual standard deviation of 0.25 (25%) and a suitable
standard deviation for dates in the more distant future is judged to be 0.75
(75%). In this case, the following mean reversion rate should be selected:
C-89
Credit Simulator
a = ( 0.25 / 0.75)2 2 = 0.055. The unit of measurement for the mean reversion
rate is one over time, with time measured in years. Reasonable values for the
mean reversion rate will usually be in the range a ≈ 0.025 –0.2. Higher values
may be appropriate when the interest rate volatilities are unusually high.
C-90
User’s Guide
Chapter 8 Implementation Issues
Curve and Scenario Interpolation

The scenario elements are applied to the curves and surfaces using linear
interpolation. For points earlier than the first scenario element and later that the
last element, horizontal extrapolation is done.
If we have a simple yield curve with these points:
Term Zero Coupon Yield
1 DAY 4%
1 YEAR 5%
5 YEAR 6%
10 YEAR 7%
And we apply the following absolute yield change scenarios:

Term Absolute Shift
3 YEAR 2%
7 YEAR 1%
The points are linearly interpolated and extrapolated:

Term Zero Coupon Yield Absolute Shift Resulting Curve
for Valuation
1 DAY 4% 2% 6%
1 YEAR 5% 2% 7%
3 YEAR 5.5% 2% 7.5%
5 YEAR 6% 1.5% 7.5%
7 YEAR 6.4% 1% 7.4%
10 YEAR 7% 1% 8%
C-91
Credit Simulator
Simulating Yield Spread Changes

To simulate volatility in yield spreads:
1. Create a dependent curve. For example, dependent curve Corporate_Bond =
derived curve Government + simple curve Corporate_Spread.
2. Create scenario elements for the spread. If you are using Monte Carlo, add
volatilities (and perhaps correlations) for the spread to the dataset. If you are
using historical simulation, add historical spread data. For ad-hoc scenarios,
add the spread scenario elements manually.
3. Add an index substitution. The portfolio index should be the reference index
of the spread curve. The scenario index should be the index of the spread
scenario element.
OTC Contracts vs. Negotiable

Securities
This majority of this document is written from the perspective that the
counterparty of credit exposure for a transaction is one of the counterparties to
the transaction. This is valid only for OTC contracts (such as swaps) that cannot
be resold in an after-market.
Negotiable Securities (such as bonds) have only settlement risk to the other
counterparty of the transaction. Although this is a type of credit risk, it is of
short horizon and is not measured by Credit Simulator. The true credit exposure
of a bond or stock is to the issuer. Credit Simulator can measure this exposure,
provided that the security issuer is represented in the system as a counterparty.
Exchange-traded instruments that are settled daily by the exchange are another
special case. The immediate risk is limited to the one-day settlement risk with
the exchange (though there are also liquidity and margin issues.) Credit
Simulator does not take into account the amortizing of credit exposure by daily
settlement. There is still true, un-amortized exposure to the underlying issuer;
Credit Simulator does not capture this exposure. However, exchange-settled
instruments are usually either contracts on commodities of intrinsic worth or
financial instruments issued by sovereigns and of minimal credit risk. There is a
reasonable case for simply ignoring exchange-settled instruments and we
recommend that you exclude such instruments from the filter portfolio.
C-92
User’s Guide
Appendix 1 Volatility and Correlation Datasets
User-Created Datasets
User-created datasets must conform to the J. P. Morgan RiskMetrics v2.0 or 3.0

file format. Please see RiskMetrics Technical Document, Third Edition for a
discussion of the data semantics. The file header must contain mandatory
information on comment lines (denoted by an "*" as the first character of the
line.) Comment lines may only appear at the start of the file.
Volatility File Header
The following is a sample volatility file header:
*BANK ABCs estimate of volatilities for a one day horizon

*COLUMNS=5,LINES=448,DATE=11/01/95,VERSION Internal
*All comment lines here are ignored by the scripts
*SERIES,PRICE/YIELD,DECAYFCTR,PRICEVOL,YIELDVOL
The significant components of this header are as follows:
1. The first line is a description of the dataset. The first 80 characters of this
line are recorded in the database. The phrase "one day" or "one month" in
this line identifies the time horizon of the dataset and MUST be present.
THE DESCRIPTION LINE MUST NOT CONTAIN ANY QUOTE

CHARACTERS.
2. The second line MUST appear as shown above. The numeric value given
for the number of lines (LINES=nnn) should be the number of lines of data,
excluding all comment lines. The date given is taken as the dataset date; any
date in the filename is ignored. The word following VERSION is taken as a
dataset name and should be descriptive of the dataset. This word can be up
to 12 characters long and cannot contain any blank spaces.
3. A line containing the identifiers of the column data (as shown in line 4
above) must be present.
Correlation File Header
The following is a sample correlation file header:
*BANK ABCs estimate of correlations for a one day horizon

*COLUMNS=2,LINES=100576,DATE=11/01/95,VERSION Internal
*All comment lines here are ignored by the scripts
C-93
Credit Simulator
*SERIES,CORRELATION
The significant components of this header are as follows:
1. The first line is a description of the dataset. The phrase "one day" or "one
month" in this line identifies the time horizon of the dataset and MUST be
present. THE DESCRIPTION LINE MUST NOT CONTAIN ANY
QUOTE CHARACTERS.
2. The second line MUST appear as shown above. The numeric value given
for the number of line (LINES=nnn) should be the number of lines of data,
excluding all comment lines. The date given is taken as the dataset date (any
date in the filename is ignored). The word following VERSION is used as a
dataset name and should be descriptive of the dataset. The dataset name can
be up to 12 characters long and cannot contain blanks.
3. A line containing the identifiers of the column data (as shown in line 4
above) must be present.
Adding additional data to the

J. P. Morgan datasets
The J. P. Morgan datasets do not provide data for all possible series. Users can
add further information to the dataset values by appending the new data to the
RiskMetrics data files.
C-94
User’s Guide
Appendix 2 System Configuration for Distributed Processing
This appendix describes how to configure a system to run credit simulations in

distributed mode.
Credit Simulator Components

The Credit Simulator system consists of the following components:
1. &UHGLW6LPH[H WKHFOLHQWDSSOLFDWLRQ17RQO\
2. FRQWUROOHUH[H FRQWUROVVLPXODWLRQVUHTXHVWHGE\FOLHQWV17RU
Unix)
3. HQJLQHH[H SHUIRUPVWKHDFWXDOZRUNRIVLPXODWLRQ17RU8QL[
4. torpedo (.exe) – used by the controller to stop engines (NT or Unix)
Components 2 through 4 are the distributed components of Credit Simulator.
Credit Simulator supports these components on either NT or Unix (but not both
simultaneously). Components have the same name for NT and Unix except that,
for NT, they have the suffix “.exe”.
Distributed Component Scripts
Users must run scripts to start the distributed components. These scripts are
named after the components they start. NT scripts have the suffix “.bat.” For
example, the engine script is called startEngine on Unix, but “startEngine.bat”
on NT.
It is the machine on which a script executes that determines whether an NT or
Unix script is required (not the target machine on which the component to be
started will run). The script will execute on the same machine as the component
that runs the script. For this reason, only startServer.bat is required in the
released version of the Credit Simulator system, because only an NT client is
currently supported.
Here is a table of the distributed component scripts, together with the names of
the components responsible for running them:
Script Name Used by Component

startServer.bat CreditSim.exe
startEngine(.bat) controller(.exe)
C-95
Credit Simulator
startTorpedo(.bat) controller(.exe)
The Unix scripts are shipped as C shell scripts; they will not execute under other
types of shell. Unix files must have the executable flag set in order to be
executed.
Special Directories
Credit Simulator makes use of two special directories, the Home directory and
the Storage directory. These directories must be available (for reading and
writing) to all the components of the Credit Simulator system. If the distributed
components are to be run on Unix, a technology that allows file systems to be
shared between Unix and NT systems is required. Samba is an example of such
a technology.
The Credit Home Directory
The credit home directory contains the executable files of the distributed
components of Credit Simulator as well as the associated scripts that start the
executables. Log files written by the components during operation are also
contained in this directory.
The Credit Storage Directory
The credit storage directory contains the results of credit simulations. The bulk
of result data is written to a file; the database is used to index the files. The files
may actually be stored in subdirectories of the credit storage directory.
Environment Variables
Credit Simulator components need environment variables to find the credit

directories. These environment variables are named CREDIT_HOME and
CREDIT_STORAGE. They must be defined in every environment that
executes a credit simulator component.
The actual directories referred to by the environment variables should be the
same in each environment, although the exact value of the environment
variables may differ. For example, the home directory may reside on a Unix
system in /home/creditSim; this could be mounted as a drive under NT,
such as H:\. A common home directory is required so that log files written by
distributed components will be available to the client; a common storage
directory is obviously necessary (as described below).
The CreditSim.exe application can be locally installed on the client machine to
improve performance; it need not be installed in the home directory.
The CREDIT_STORAGE environment variable of every user must point to the
same directory in the network. When a simulation is generated, CS saves the
results data set of the simulation in the directory indicated by the
CREDIT_STORAGE variable. It saves the name of the results data set in the
database. If users have different directories specified by their
CREDIT_STORAGE variables, errors will occur when they try to load
C-96
User’s Guide
previously generated results sets, either because their CREDIT_STORAGE

variable is pointing to the incorrect directory or, more seriously, because another
user saved a results data set in the wrong directory.
In addition, for environments where multiple operating systems are used, a
utility for accessing directories transparently across operating systems must be
installed (e.g. Samba).
Setting Environment Variables

for NT
NT environment variables must be set on each machine. To set an environment

variable, right click on the My Computer icon on your desktop and select
Properties. Then select the Environment tab. You can create the variables either
as System variables or User variables. But, if you choose to create user
variables, you must create the variables both for the accounts of all Credit
Simulator users on client machines and for the Distributed Component account
on server and engine hosts. System variables apply to all accounts on a
machine.
Setting Environment Variables

for Unix
Unix environment variables are set according to the account. The Distributed
Component account is the only Unix account needed by the Credit Simulator
system. The environment variables must be set automatically upon login. One
way to do this is to put the commands that set the variables in the .alias file
in the home directory of the Distributed Component account. Under the C shell,
the setenv command sets the environment variables. For example:
setenv CREDIT_HOME /home/CreditSim
The Distributed Component Account

The distributed components of Credit Simulator require an account into which
the components can login. It is recommended that a dedicated account be used
for this purpose. One reason for this suggestion is that the NT rsh service will
not work correctly when it logs in as System (see below).
The Distributed Component account must be available on all machines (NT or
Unix) that will host a distributed component. The account must have read and
write access to the home and storage directories. It must also have permission to
execute Credit Simulator components. NT accounts must have all Credit
Simulator DLLs in their path environment variables. Unix accounts must have
all Credit Simulator shared object libraries in their LD_LIBRARY_PATH
environment variables.
Account Name in
startServer.bat and
startEngine.bat
Using notepad or another text editor, edit the file startServer.bat in the Credit
Simulator installation. Change the line that reads:
C-97
Credit Simulator
start /b /high rsh %machineName% -l infinity

%CREDIT_HOME%\engine %parameters% >
%CREDIT_HOME%\%logfile%
by substituting the name of the Distributed Component account for infinity.
If the distributed components are run on NT, do the same for the
startEngine.bat file.
RSH on NT
The rsh (Remote Shell Service) program starts the distributed components of
Credit Simulator. Unix machines normally have a remote shell service, but NT
machines must have rsh specially installed. Because rsh starts the distributed
components, it must be installed on every NT machine that will start a
distributed component. At the very least, this means that rsh must be installed
on every Credit Simulator client machine.
Although several vendors provide rsh utilities, the Microsoft version is
recommended for Credit Simulator on NT. While it may be technically inferior
to some products, this product can be considered standard and is widely
available.
Installing RSH
The following steps will guide you through the installation of rsh:
1. Unzip the rsh package in a temporary directory and run
rshsetup.exe
2. Open the Services item in the Control Panel and select the “Remote
Shell Service” line. Then click on the Startup button.
3. Select Automatic in the Startup Type section.
4. Select This Account in the Log On As section and enter the
name of the Distributed Component account and the password for the
account. (The rsh service will not work properly when services log on
as System.)
5. Restart the machine
Ensure that the Computer

Names are Upper Case
Some components of the NT network system spontaneously convert computer

names to upper case; others do not. To ensure consistency, name all computers
that will host a credit server or engine in upper case in the Network item of the
Control Panel. Follow these steps:
1. Open the Network item of the Control Panel.
2. In the Identification tab, check that the value in the
Computer Name field is in upper case.
3. In the Protocols tab, select the TCP/IP Protocol line from
Network Protocols and open the Properties dialog.
C-98
User’s Guide
4. In the DNS tab, check that the value of the Host Name field is upper
case.
5. In the WINS Address sheet, select Enable LMHOSTS Lookup.
Edit .rhost Files
The WINNT\SYSTEM32\Drivers\etc\.rhost file specifies

combinations of accounts and machines that are allowed access to the machine
on which the file resides. There is a corresponding file in Unix systems. It
contains one-line entries of the form:
MACHINE_NAME user_name
Each user that requires access from a particular machine must have a separate
entry. Each accessing machine used by a given user also requires a separate
entry.
The machine that will host the controller must grant access to both the real user
account and the Distributed Component account for each machine that runs the
Credit Simulator client:
MY_MACHINE my_account
MY_MACHINE credit_simulator_account
Each machine that will host a credit engine must grant access to the controller
host machine using the Distributed Component account.
Edit the Imhost File
The WINNT\SYSTEM32\Drivers\etc\lmhost file specifies the IP

addresses corresponding to the names of remote machines. There is a
corresponding file in Unix systems. Each client machine must contain an entry
in this file for the machine that will host the credit server. The credit server
machine must contain a line in its lmhost file for each machine that will host an
engine. The lines have the form:
ip_address MACHINE_NAME
Ask the system administrator for help setting up this file. Note that some
installations may use the hosts file, which performs the same functions as
lmhosts and contains entries in the same format.
C-99
Credit Simulator
C-100
User’s Guide
Appendix 3 12 Steps to Using Credit Simulator
This section is designed for first-time users of Credit Simulator. It outlines the
steps for calculating Credit Exposure and Losses using the Credit Simulator
application. Each of the steps (outlined below) is described in detail in the
previous chapters of this manual.
Step 1: Define the Portfolio and Valuation Association

Define portfolio(s) using the Infinity Derivatives Trader application.
Also, in the Trader application, create a Valuation Association that can be used
to price the portfolio. To ensure that the Valuation Association is correctly
defined, run a Mark-to-Market report on your portfolio.
For more information about this step, please see the Infinity Derivatives Trader
Reference Guide.
Step 2: Set Parameters in the Exposure Settings window

To invoke the Exposure Settings window, select the Settings: Exposure
Settings menu command. In the Exposure Settings window, it is not necessary
to edit the default values, with the following exceptions:
1. Select “By Name” radio buttons in the Bank Breakout and Counterparty
Breakout areas (top, right portion of the window).
2. Choose the portfolio you created in Trader in the Filter Portfolio list box
(bottom, left portion of the window).
For more information about this step, please see page B-68.
Step 3: Define the Credit Levels

Credit Simulation uses credit information (default probability and recovery rate)
linked to credit ratings. Define the credit rating categories (Moody’s, S&P, or
your own).
To invoke the Credit Level window, select the Settings: Credit Levels menu
command.
C-101
Credit Simulator
Step 4: Define the Credit Data (Probabilities of Default,

Recovery Rates)
To access the Credit Level Data window, select the Settings: Credit Level
Data menu command.
Recovery rates are defined for each credit rating (first column). Default
probabilities can be defined for each of the forward points. For example, the
1YEAR column should contain the default probability for the next year.
Step 5: Import Volatility/Correlation Datasets

If you have not already imported the volatility/correlation datasets (using Market
Simulator), import the datasets that you will use in generating the Monte Carlo
scenario set series.
Select the Settings: Import Datasets menu command to invoke the Import
Datasets window.
To view the previously imported datasets, select the Settings: View Datasets
menu command.
Step 6: Define Counterparties

Click on the Counterparty bar, then right click in the Navigation Panel and
select “New” to invoke the Counterparty window. Credit Simulator uses the
counterparties that were defined in ciMan. In this release, you must select the
counterparty name and enter additional information (credit level, country,
industry, parent entity). The “Can be bank” checkbox should be selected for all
internal counterparties.
Step 7: Define Netting Agreements

Click on the Netting Agreements bar, then right click in the Navigation Panel
and select “New” to invoke the Netting Agreement window.
“Bank” is any entity of the PBE. Select the “Close-out Netting” checkbox
(lower right portion of the window) to indicate a netting agreement. Priority
level is meaningful when a transaction meets the definition of more than one
netting agreement. In such a case, the trade will be netted only under the highest
priority agreement.
C-102
User’s Guide
Step 8: Define Scenario Set Series

Producing a Monte Carlo Scenario Set Series involves two steps:
1. Creating a Monte Carlo Scenario Set Template
2. Creating a Monte Carlo Scenario Set
Click on the Scenarios bar. Then right-click in the Navigation Panel and select
“Define Monte Carlo Scenarios” from the popup menu. This will invoke the
Scenario Set Series Generator window. In this window, you will enter the
template parameters. In this window, Reversion Speeds are needed for each
currency included in the template. Define a Reversion Speed Set. Forward
Terms are the forward points at which you want to compute the credit exposure.
Once you have created the scenario template, right click on the template name
and select “Create MC Scenarios” from the popup menu. Each Monte Carlo
Scenario Set (or instance of the template) corresponds to a given
volatility/correlation dataset.
Step 9: Define Index Substitutions

Click on the Index Substitutions bar. Then right-click in the Navigation Panel
and select “New” from the popup menu. Allow the application to set the default
substitutions. In the Index Substitutions window, you will map information
from the volatility and correlation dataset to the appropriate pieces of market
data in the Infinity Data Model.
Step 10: Define Valuation Parameters

Click on the Valuation Parameters bar. Creating Valuation Parameters
involves two steps:
1. Right-click in the Navigation Panel and select “New” from the popup menu.
This will invoke the Valuation Parameters window. Only the Name and
Description fields will be editable. By entering the Name and Description,
you will have created the Valuation Parameters template.
2. Once you have created the template, right-click on the template name and
select “New” from the popup menu. This will allow you to enter a specific
instance of the Valuation Parameters. Edit the fields in the lower portion of
the window.
Step 11: Run Exposure Calculations

Select the Results bar. Then select the Results tab. Running the exposure
calculations is a three-step process:
C-103
Credit Simulator
1. Create an Exposure Set Template by right-clicking in the Navigation Panel

and selecting “New” from the popup menu. This will invoke the Exposure
Set window and the fields in the upper portion of the window will be
editable.
2. Create a specific, time-stamped instance of the template by right-clicking on
the template name and selecting “New” from the popup menu.
Please note that the Directory is actually the subdirectory of the

CREDIT_STORAGE directory. In the current version of this release, the
CREDIT_STORAGE environment variable should be set to the directory in
which Credit Simulator is located (e.g. C:\INFINITY\CREDITSIM). You
may type “exposures” in the Directory field. Then your simulation results
will be save to the following directory:
C:\INFINITY\CREDITSIM\exposures.
3. Right-click on the date-stamp of the Exposure Set you wish to use for the
simulation. Then select “Run” from the popup menu. The actual exposure
calculations will be done at this time.
Step 12: Viewing Simulation Results

Viewing your simulation results is a two step process:
1. First, you must create a Credit Hierarchy. Click on the Hierarchy tab in the
Results section. Right-click in the Navigation Panel and select “New
Hierarchy” from the popup menu. This will invoke the Hierarchy window.
Enter the Name, Description, and Exposure Set. Once you have created a
hierarchy, right-click on it and select “Insert Level” from the popup menu.
This command will allow you to add nodes to the hierarchy you have
created.
2. Once you have created a Credit Hierarchy, you can view the results. Click
on a node of your hierarchy (in the Hierarchy tab). Then select the Results
tab. Choose the Exposure Set that was used to create the Credit Hierarchy
and double–click on the Exposure Set. This will display the types of
exposure results: Credit Exposure, Credit Losses, Scenario Exposure,
Scenario Losses. Click on one of them to display the simulation results.
Double click on the graph at a given forward point to have a detailed view
of that point in time.
By exporting the results to an Excel or Text file, users can export the Credit
Exposures / Losses to a custom report. Right-click on a result type (e.g. Credit
Exposure) and select “Create Report” from the popup menu.
For more information about this step, please see page Error! Bookmark not
defined..
C-104
User’s Guide
Index
A D
absolute change, B-33 data
absolute value, B-33 fetching, B-23
asset required, A-14
index substitution, B-42 data requirements, A-9
asset types, B-28 dataset
association BIS, B-26
valuation parameters, B-46 date, B-26
horizon, B-27
RiskMetrics, B-26
B user-defined, B-26
datasets, B-65
bank date formats, A-14
exposure set, B-48 deleting simulations, B-62
bank breakout description
settings, B-64 credit hierarchy, B-52
base currency exposure set, B-48
valuation parameters, B-46 valuation parameters, B-45
base valuation date, B-49 directory
exposure set, B-49
display as table, B-60
C
can be bank, B-36
change type, B-33
E
close-out netting, B-40 effective date
controller host netting agreement, B-39
settings, B-64 engine hosts
copy and paste settings, B-63
viewing results, B-61 exception trades
correlation datasets, B-67 netting agreement, B-39
counterpartie, B-22 exclude cash
counterparties valuation parameters, B-46
exposure set, B-49 expiry date
counterparty, B-39 netting agreement, B-39
counterparty breakout explicit scenarios
settings, B-64 creating, B-29
counterparty data, B-35 exposure calculation, C-75
credit exposure, A-7 exposure frequency
example, C-76 viewing results, B-57
viewing results, B-57 exposure set
credit hierarchy, B-51 credit hierarchy, B-52
credit level, B-37
credit losses
viewing results, B-58
currencies
F
netting agreement, B-39 filter portfolio, B-64
currency fractional change, B-33
base, B-24, B-30
in scenario set, B-28
Customer Information Manager, B-36
C-105
Credit Simulator
portfolio
H currency, B-43
index, B-43
hierarchy metric, B-43
example, B-54 portfolios
defining, B-19
price metric, B-32
I printing
index priority, B-44
currency, B-32 netting agreement, B-39
in scenario element, B-32 products, B-39
index substitution
valuation parameters, B-46
index substitutions, B-41
deleting, B-44
R
editing, B-41 random seed, B-25
Indexes refresh
in scenario set, B-28 results, B-62
industry classification, B-36 reports, B-61
Infinity Data Model, B-19 reversion speed, B-25
Installation, A-14 RiskMetrics
interpolation data, A-14
curves, C-82 root node name
credit hierarchy, B-52
L S
loading simulation results, B-55
logging in, A-15 scenario
loss calculations, C-78 currency, B-43
index, B-43
metric, B-43
M scenario exposure
mean reversion, B-27 scenario losses
menu, B-21 viewing results, B-59
moment matching, B-27 scenario set, B-50
Monte Carlo, B-64 deleting, B-32
random seed, B-64 exposure set, B-49
scenario generation, B-29 scenario set series, B-23
Monte Carlo scenarios scenario sets
creating, B-23 creating new, B-30
scenarios
creating, B-23
N number of, B-25
scripts, C-84
settings, B-63
name
simulation
credit hierarchy, B-51
running, B-47
exposure set, B-48
simulation results
deleting, B-62
netting
stratified sampling, B-27
netting agreements, B-37
nodes
credit hierarchy, B-52 T
template
P Monte Carlo, B-24
tenor, B-32
timestamp
parent entity, B-36
exposure set, B-49
password, A-15
C-106
User’s Guide
valuation parameters, B-44, B-45 exposure set, B-49

vol metric, B-32
volatilities and correlations, B-65
U volatility datasets, B-67
use implied forward

valuation parameters, B-46 Y
yield spread
V simulating volatility, B-46, C-83
C-107

Infinity Platform Credit Simulator User's Guide: Version 99.1, NT

Transféré par

Informations du document

Titre original

Copyright

Formats disponibles

Partager ce document

Partager ou intégrer le document

Options de partage

Avez-vous trouvé ce document utile ?

Ce contenu est-il inapproprié ?

Droits d'auteur :

Formats disponibles

Infinity Platform Credit Simulator User's Guide: Version 99.1, NT

Transféré par

Droits d'auteur :

Formats disponibles

Infinity Platform

Credit Simulator User’s Guide

Licenses and Trademarks

Infinity Technical Support

PART A GETTING STARTED ............................................................................................................................ A-5

CHAPTER 3 CREDIT AND NETTING DATA ......................................................................................................B-23

CHAPTER 4 CREATING SCENARIOS ................................................................................................................B-29

CHAPTER 5 RUNNING EXPOSURE SIMULATIONS ..........................................................................................B-43

CHAPTER 6 MENU COMMANDS .......................................................................................................................B-67

PART C METHODOLOGY............................................................................................................................... C-81

CHAPTER 8 IMPLEMENTATION ISSUES ...........................................................................................................C-91

APPENDIX 1 VOLATILITY AND CORRELATION DATASETS ..................................................................... C-93

APPENDIX 2 SYSTEM CONFIGURATION FOR DISTRIBUTED PROCESSING ........................................... C-95

APPENDIX 3 12 STEPS TO USING CREDIT SIMULATOR .......................................................................... C-101

Chapter 1 Introduction to Credit Simulator

What is Credit Simulator?

each selected horizon.

Infinity Platform Integration

Market Simulator Credit Simulator

Simulation Toolkit Extended Simulation Toolkit

Valuation Market Customer

Major architectural improvements to the simulation engines accommodate the

Credit Simulator Components

Credit Data Position Market Data Market Data Valuation

Scenario Set Series

Netting Portfolio Exposure

• 0HDQUHYHUVLRQ The user specifies the estimated reversion speed and

100 Scenarios, Random 100 Scenarios Stratified

DEM/USD FX Rate Frequency Distribution

Exposure Calculation Engine

Portfolio Exposure Analysis

Dual Set Model

In addition, Credit Simulator uses a dual-set model, as shown below.

Working Set When Complete Current Set

Open Model Interface

The Infinity Valuation Framework allows external pricing models to be used in

About this Manual

Installing the Software

Getting RiskMetrics Data

To connect to a server or database, input the proper information in the relevant

USING CREDIT SIMULATOR

Chapter 2 Simulation Step by Step

Full valuation simulation involves three steps generating scenarios, running

Defining the Portfolio and Market Data

Navigating The Application

• Counterparties (see page B-23)

The following table provides a map of the application screens.

Counterparties Counterparty New (B-23)

(see page B-29) Data Edit (B-24)

(see page B-46) Delete (B-49)

Chapter 3 Credit and Netting Data

Internal and External Counterparties

To enter or modify counterparty data, select the Counterparties section of the

This is the industry classification of the counterparty. It is used for reporting on

In the Netting Agreement window, the ID number identifies the agreement in

This field contains a description of the agreement. It is provided for information

Only trade legs denominated in an Included Currency will be included under

Chapter 4 Creating Scenarios

Using Credit Simulator, it is possible to create two types of scenarios:

The process of generating each of these types of scenarios is described in the

Scenario Set Series Names and

Creating Monte Carlo Scenarios

Fetching the Volatility and

• 0HDQUHYHUVLRQ The user specifies the estimated reversion speed and

1. Create a new Valuation Parameters name 5LJKWFOLFNRQWKHHPSW\