Credit Metrics - Part II

Credit metrics as discussed in part I is dependent on the transition matrix for the result.

We will take two bond portfolio for the analysis and will use bivaraite normal distribution to combine both the distribution and to get resultant distribution for the portfolio. We will follow below stepwise approach for the calculations-

1. Take down the probability of transition for each of the portfolio

2. Calculate inverse for each of the number using normsinv(number) formula in excel.

Refer to image 1

3. Combine numbers using bivar formula in excel and using correlation. In this case bivar(A_number,B_Number,Rho).

A_Number and B_Number are inverted numbers from the portfolios.

Rho is the correlation between two portfolios - .20 in this case

4. Calculate this number for all the combinations.

5. You will get a chart like shown in the attached image (image 2), this chart represent cumulative probability of transition.

6. Take down the number corresponding to 5%number, it will be our VaR and answer in this case was (-) 6. refer to yellow box in image 3