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{{g}}''Warning: ramblings of an untutored maniac here.'' | {{g}}''Warning: ramblings of an untutored maniac here.'' | ||
===[[Credit value adjustment]]s=== | |||
A [[credit value adjustment]] — to its friends '''[[CVA]]''' — is a calculation made by financial reporting types to [[financial instrument]]s one holds to account for changes in the [[creditworthiness]] of the [[issuer]] of those instruments since their issue. For a liquid instrument the [[CVA]] ought really to be baked into the [[mark-to-market]] value of the instrument. For a [[Variation margin|collateralised]] one, it ought to be small. As far as this [[Jolly Contrarian|bear of little brain]] can see, it ought really to be the difference between the [[present value]] of the notional [[cashflows]] due on that instrument (that is, ignoring the risk of [[default]]) and the price at which that instrument is trading. | A [[credit value adjustment]] — to its friends '''[[CVA]]''' — is a calculation made by financial reporting types to [[financial instrument]]s one holds to account for changes in the [[creditworthiness]] of the [[issuer]] of those instruments since their issue. For a liquid instrument the [[CVA]] ought really to be baked into the [[mark-to-market]] value of the instrument. For a [[Variation margin|collateralised]] one, it ought to be small. As far as this [[Jolly Contrarian|bear of little brain]] can see, it ought really to be the difference between the [[present value]] of the notional [[cashflows]] due on that instrument (that is, ignoring the risk of [[default]]) and the price at which that instrument is trading. | ||
===[[Debt value adjustment]]s=== | |||
:''“[[DVA]] has caused a lot of confusion because banks are allowed to record gains as their credit quality deteriorates. While there are pros and cons to including [[DVA]] in earnings, most people see it as accounting gimmickry that doesn’t reflect any true economic value.” | |||
::—David Kelly, Quantifi, 2009, quoted in [https://www.euromoney.com/article/b12kjc667rjrsq/the-truth-behind-cvas-dvas-and-banking-results?copyrightInfo=true Euromoney] | |||
The imposition of [[CVA]] adjustments during the [[global financial crisis]] — it | The imposition of [[CVA]] adjustments during the [[global financial crisis]] — it was a [[Basel]] requirement — where counterparties had, effectively, to discount the value of their claims under [[derivative]] contracts due to deterioration in their counterparties’ [[creditworthiness]], led resourceful types to wonder whether they shouldn’t also be able to discount the book value of their ''[[liability|liabilities]]'' under the same {{t|contract}}s due to a deterioration in their ''own'' [[creditworthiness]]. This they called “[[debt value adjustment]]s”, and while it was a thing, it didn’t fare quite so well and these days there aren’t as many Investopedia articles about it. | ||
There is a neat logic to this — if I consider | There is a neat logic to this — if I consider [[out-of-the-money]] exposures to be my term [[indebtedness]], then if my prospects have worsened, I would be able to buy this back at a discount to its face value for exactly the same reason, so why shouldn’t I mark it down? — but you would not be alone if you felt something tugging at your gut saying this feels wrong. And so it is. | ||
If you think your own-credit deterioration is an excuse to book a profit, you should get your coat. Just because, as you lurch towards [[insolvency]], the value of your liabilities ''to others'' tends to zero, it doesn’t mean their cost ''to you'' tends to zero. You are still fully liable for the risk-free amount of that [[indebtedness]], come what may. That you should have collapsed into ignominious torpor of [[bankruptcy]] before being able to honour it does not mean that obligation doesn’t exist, and it certainly doesn’t go to your [[pnl]]. | If you think your own-credit deterioration is an excuse to book a profit, you should get your coat. Just because, as you lurch towards [[insolvency]], the value of your liabilities ''to others'' tends to zero, it doesn’t mean their cost ''to you'' tends to zero. You are still fully liable for the risk-free amount of that [[indebtedness]], come what may. That you should have collapsed into ignominious torpor of [[bankruptcy]] before being able to honour it does not mean that obligation doesn’t exist, and it certainly doesn’t go to your [[pnl]]. | ||
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“But I could borrow so —” and here, dear reader, follows a pause. “Oh, hang on. I think I see the problem here.” | “But I could borrow so —” and here, dear reader, follows a pause. “Oh, hang on. I think I see the problem here.” | ||
Right. You don’t have any money, so you would have to borrow it. Even if you could find someone prepared to lend to a | Right. You don’t have any money, so you would have to borrow it. Even if you could find someone prepared to lend to a soon-to-be-bankrupt company (look, it does happen), it would lend to you at your current state of indebtedness. So you would be trading your apparently cheap [[indebtedness]] for ''more expensive [[indebtedness]]''. | ||
{{sa}} | |||
*[https://ftalphaville.ft.com/2011/10/13/701766/how-one-banks-default-is-the-same-banks-gain/ Lisa Pollack of FT Alphaville in typically sparkling form] | |||