Waterfall Language - Accidental Trader Game
Contents
1. 16 INTC OSE 16 Renting From The 17 Renting From Other Teams 17 18 PORTFOLIO PROGRESS 19 Average Portfolio Rating 1 19 Probability Default 19 19 Cost Of Capua 20 21 WORLD EVENTS meanemansiaeeensenceee 21 satiet A ENAT T 21 READY BUTTON AND TRAFFIC 22 BASIC GAME STRATEGIES wisssssscescicssccassesstcsossesvesescesssvececoscensesssscbacccscsscsoassesdevestecessestooosceatesessosesses 23 HOW THE SCORING cere onoaiia E ES 23 MANAGING PROBABILITY OF 24 THE COST OF CAPITAL 24 TRADING EXPOSURES 25 BUYING PROTECTION RISK ELIMINATION cccccccccccccccceccccceccccccseseccecscccsesescecscsescecsesescesseesseeeeceeseeusesnaea 25 SELLING PROTECTION TAKING MORE RISK TO REDUCE THE COST OF CAPITAL ccccccceseseseeeeeeeeeeees 26 RENTING CAPITAL FROM OTHER TEAMS 26 The Accidental Trader Game R amp R Consulting Inc Introduction The Accidental Trader Game2. 7 Jones Apparel Group Inc has been upgraded from A2 to Aa2 World Events occur randomly Nevertheless there is logic behind this randomness Thus it s very unlikely that an exposure rated AAA would ever default However some rare cases an exposure rated AA will be made to default This can happen in the real world and the game carries this possibility as well Last Actions The Last Actions screen keeps track of actions taken by players in the course of the session Every action has a corresponding time step This information can be used to 21 The Accidental Trader Game R amp R Consulting Inc refresh your memory on which actions were taken previously and to see how they affected the current situation Among other things participants can see how much capital they rented from the market what CDS positions they entered to which exposures where traded etc Ready Button and Traffic Light The last button on the main user screen is the Ready button This button should be pressed when a team made all the decisions for current time step Once pressed there is no recourse It s very important not to forget to rent Short Term Capital when it s needed of course before pressing the Ready button Therefore the system checks if Short Term Capital was rented from the market If it wasn t the system asks the player or team to confirm positively that not renting an STC was a consciou
3. Using this graph players can evaluate their performance from one time step to the next and potentially correct their strategies Thus the expense meter can be regarded as the main game benchmark 20 The Accidental Trader Game R amp R Consulting Inc Skype Name The Skype button acts as small communication center providing the list of all playing teams and their Skype IDs Players will need to use Skype to make verbal capital trading agreements with each other The Status field shows whether a team is available to talk and if pressed automatically connects Skype to the corresponding team World Events This is an informational screen displaying a log of all of all exposure upgrades downgrades and defaults Every entry shows the corresponding time step All parts of this log have are shown to participants before every round Therefore the purpose of this screen is to provide players with additional historical information about World Events Time Step Event 8 Assurant Inc has been downgraded from to Baa3 8 Apache Corporation has been downgraded from to 2 8 TransMontaigne Inc has been downgraded from Baa2 to Bal Motorola Inc has been downgraded from Baal to Bal JPMorgan Chase amp Co has been downgraded from Bai to B1 Praxair Inc has been downgraded from Baa2 to Baa3 CVS Corporation has been upgraded from 1 to 2 BellSouth Corporation has been upgraded from A2 to Aa3
4. The Accidental Trader Game R amp R Consulting Inc THE ACCIDENTAL TRADER GAME R amp R Consulting 2007 http atg creditspectrum The Accidental Trader Game R amp R Consulting Inc sessusucchsossudcsssctuscesessecesecnesesunenseveesesssesgesstsvexteosnease 3 MAIN ELEMENTS THE GAME wiss cccsssisscssescsssevecscsvesosscesssossecenscesescoseesecsesscsecsosesceccssensessesecssssstessoeess 4 tees ara a e aa tees 4 4 5 TV QU Gs ca ccess Shcc05 neaseabeasendatoescesetavessnasyeasuedeanndetsousdssebsgreshesuneascadeseadeatons 5 Buying and Selling Protection 5 CAPITA hois eina aa E E Ea a E a a aaea aaa aaa a a a aea aaaea aaa aia ai 7 L ng Term iein ae EEA ra AEE A EE EA E A EE EEEE 7 Short Term Capital E aa 7 Renne Capitalas sea 7 TW SERUINTEREA 8 MAIN SCREEN 10 12 13 Expense A ESES 14 POPU 14 CONTE OI shag 15 CAPITAL MANAGEMENT
5. Short Term Capital Mangement capital Interest Rate Rent From The Market The small graph on the right hand side shows interest rates The green line ave indicates Long Term Capital 9 64 interest rate which is 0 1 constant over the course of the game Risk Capital Exchange Rent The blue line represents Short Term Capital interest rate which changes from one time step to another Any player can communicate with other players using the Skype buttons placed front of team names in the table below As mentioned before there are two ways to obtain Short Term Capital i e from the market and from other teams We will now look at both ways a little closer Interest Rates As you can see on the graph the Short Term Capital interest rate changes over time It s always higher than the long term rate and intimately tied to the team s portfolio default probability Normally when a team s default probability rises this rate will increase and conversely when the default probability decreases the rate decreases Long Term capital is a much cheaper source of capital However it lacks the flexibility provided by Short Term Capital Therefore it is a good idea to wisely allocate an optimal amount of Long Term Capital at the beginning of every session Participants should be careful when making a decision about this allocation For instance allocating too much Long Term Capital can lock in a team s total capit
6. As a result of a credit event or a natural evolution every exposure can default Defaulted exposures stay in the original holder s portfolio but are no longer used to compute risk characteristics It is also not possible to trade an exposure after it has defaulted buy and sell protection on it or do any other operation available with respect to the non defaulted exposures The loss in the event of default is added to the Total Realized Losses account and displayed in real time on the team s main screen Ratings Letter grade ratings are directly connected to the exposure s probability of default which itself varies naturally with time The rating table can be accessed from the main screen more on this in the user interface section below Ratings are presented for informational purposes only All computations use actual default probabilities However letter grade ratings are easier to monitor and interpret for most market participants Trading Every exposure in the portfolio can be traded Every month a certain number of possible trading candidates will be available to all teams These choices consist of exposures anti correlated to the portfolio as a whole There is a small transaction cost involved in trading but in general it does benefit the risk manager to replace a highly risky exposure with an anti correlated one because as a result of this transaction VaR will decrease As a result the amount of required risk capital will be
7. Ask the administrator which game was created for you the name of this game does not appear on the list please click the refresh games list button below Once ready press the submit button R amp R Consulting Accidental Trader Game team identification repeat password Password skype id email address Registration Screen reg ter reset The first item in the game drop down box will be last game Players should choose this item if they wish to continue playing the previous game they were playing and stopped playing for some reason that game is still running you can easily join back and start right from the place you stopped This feature is useful in case the team s web browser or computer had to be rebooted or if the game was postponed for a period of time such as lunch The Accidental Trader Game R amp R Consulting Inc Initial Capital Setup Before beginning any new session participating teams will be asked to set up their capital structure As mentioned above this will consist of two parts Long Term and Short Term Capital The capital setup screen is shown below Observed changes results during the period Welcome to the new session Your initial portfolio has been set up Please make a decision about initial allocation of your capital Funds available are equal to the VAR of your portoflio Therefore you can distibute 617 45 between lo
8. Remember my password lt ACCIDENTAL TRADER GAME RBA bn mamn cradtepectram com Now you will need a log in name and a password to login to the server This information will be provided to you by the game administrator This process will let you log in to the server not to the particular game Usually all participants will have the same name and password at this step After logging into the server each team will have an ability to choose which game to play register itself continue playing a previous game etc The Accidental Trader Game R amp R Consulting Inc Join the Game R amp R Consulting The Accidental Trader Game Click here to register team identification Speculator password Training Game Creating New Account If you haven t registered your team yet click on the Click here to register link The registration form will come up Please provide all required information including Skype id which is important for you and other teams to be communicate during the game After that click on the register button A confirmation screen will be displayed Now your team can join any new game from the log in screen Re Joining the Last Game If you have registered your team before now is the time to join one of the new games Type your teams name password and choose a game from the drop down box
9. is an educational tool designed to simulate the real life experience of a risk officer managing the credit risks of a large portfolio of corporate bond or loan exposures Delegates have an opportunity to manage a large portfolio undergoing multi period credit challenges by adopting various credit risk management strategies to keep the portfolio probability of default Pd at a pre determined value which the game administrator has set using a corresponding Value at Risk VaR level In addition the team s portfolio default probability must not exceed a given critical level no matter what else is going on If this level is breached the game considers that the manager or team of managers has lost the ability to control the portfolio That outcome corresponds in practice to economic loss for the firm and probable job loss for the manager The game ends after a certain number of time periods usually twelve or when each team but the last the winning team is out of business If more than one team survives the team with the best Pd record is declared the winner statistic factor while other teams are ranked by their longevity in the game stochastic factor At the beginning of the game each team is provided with an initial portfolio of risky exposures All exposures are assigned a credit rating reflecting its ex ante probability of default Associated with each risky exposure is a set of financial characteristics commonly used as input varia
10. lower Consequently less short term capital will be needed and lower interest payments will be made to those who provide such capital thus decreasing the total cost of risk management If a manager has bought or sold protection on the traded exposure the said CDS contract will be automatically terminated upon trade execution Buying and Selling Protection Every participant can buy or sell protection on any exposure in the portfolio Buying protection will attract a known premium every month based on the annual CDS spread for the target exposure The notional amount of protection purchased or sold is selected as an arbitrary percentage of the exposure s loan equivalent exposure Therefore to The Accidental Trader Game R amp R Consulting Inc fully protect an exposure a notional amount equal to LGD should be purchased On the other hand any amount of CDS notional can be purchased If the exposure defaults the protection buyer will receive the corresponding LEE amount and the CDS contract will be terminated Protection can also be sold on the open market However the amount of protection which can be sold is limited by market interest As a result of selling protection via a CDS contract the seller will collect monthly premiums but will have higher expected losses which will increase the selling team s capital requirements If a credit event occurs and the target exposure defaults the seller will have to pay the amount corresp
11. Probability of default One of the most important exposure characteristics It is used to compute the likelihood that an exposure will default its credit rating and its CDS spread It also changes naturally as time passes based on the behavior of an arbitrary driving function y t and sometimes randomly jumps up or down as a result of world events generated by the system a Levi jump process Historical data describing probability of default x t and the driving function y t are displayed on the exposure screen as well e Loan Equivalent Exposure LEE This variable shows the dollar amount invested in each exposure For the sake of simplicity LEE is assumed to be constant The Accidental Trader Game R amp R Consulting Inc across all portfolio exposures The LEE amount influences the loss profit profile in case of credit events as well as CDS premia received or paid e Loss Given Default LGD The percentage of LEE which will be lost if the corresponding exposure defaults LGD is used to compute expected losses VaR and the consequence to the holder of the exposure or CDS seller when default occurs e CDS Spread Annual premium received or paid for protection on any given exposure The more risky the exposure the higher its CDS spread The spread changes with time depending on the exposure s system computed probability of default to reflect market conditions For the sake of simplicity we assume that the bid ask spread is zero
12. al amount at a relatively high level and hence prevent the portfolio s probability of default from being maintained at the desired level This means that the portfolio default probability will be too low even with zero Short Term Capital allocation Conversely allocating too little may lead to a higher total cost of capital and therefore to abnormally high total capital expenses 16 The Accidental Trader Game R amp R Consulting Inc Renting from the Market The first and most convenient way to rent Short Term capital is to rent it from the market Players can see the annual cost of this form of capital on the main screen on the capital management screen next to the Amount field and on the associated graph Any desired positive amount of Short Term capital can be requested and obtained from the market To do so simply enter the amount you need on the Capital Management screen and press the Confirm button Be careful while making a decision about the amount you need Renting too little can lead to a very high portfolio default probability which means that your portfolio s default probability would exceed the Doomsday value leading to your expulsion from the session If that happens you will not be able to continue playing until the subsequent session if any Renting From Other Teams The second method of acquiring Short Term Capital is to rent it from other participating teams Please note that it is not pos
13. bles in credit risk modeling and management such as the recovery rate loan equivalent exposure and credit default swap CDS spread Those characteristics change with the passage of time and trigger various credit events such as upgrades downgrades and defaults which are reported at the beginning of each time step or round So are key portfolio level parametric averages portfolio mean loss portfolio loss standard deviation and VaR to help managers in forming risk judgments and making tactical portfolio adjustments At the beginning of each time step teams borrow short term funds from the market or one another in order to keep the portfolio probability of default at the target level Teams can improve their performance through various risk management tactics They can swap out of risky exposures for anti correlated equivalents to reduce portfolio sensitivity to extreme events or buy or sell CDS contracts on their portfolio exposures By doing so teams can realize gains or losses as well as increase or decrease their exposure to the market The Accidental Trader Game R amp R Consulting Inc Main Elements of the Game Portfolio Portfolio is the most general and most important concept in the game After all managing risks of a portfolio as a whole is the main goal of a risk manager The portfolio consists of the set of N risky exposures whereby N is arbitrary Each exposure taken alone does not carry much information for the ri
14. he period Downgrade Upgrade YRC Worldwide Inc has been upgraded from to 1 1 Owens amp Minor Inc has been downgraded from 2 to Ba2 Inc has been upgraded from Baa3 to Baal 1 Cendant Corporation has been downgraded from Baa3 to Ba2 3 Inc has been upgraded from Baa3 to 1 Land O Lakes Inc has been downgraded from to B1 TransMontaigne Inc has been upgraded from Bal to Baa2 Pulte Homes Inc has been downgraded from 2 Baa2 3 Coors Brewing Company has been upgraded from 2 to Baal t KeySpan Corporation has been downgraded from Baal to Baa2 4 Google Inc has been upgraded from Baa2 to NNNnnn Lockheed Martin Corporation has been downgraded from Baa2 to 2 Default 5 Eli Lilly and Company has defaulted Confirm and Close It informs players about what happened in the game s world during the past month The top part of the screen shows upgrades and downgrades Upgrades are indicated by green down arrow symbols The direction of the arrow means that the probability of default went down hence the green improvement color On the other hand when an exposure s default probability went up a red deterioration arrow is displayed Participants will also be able to see the name of each upgraded downgraded exposure and how its letter grade credit rating has changed The screen section beneath upgrades and downgrades shows defa
15. in characteristics see above To obtain more detailed information about particular exposures you need to click on its name For a description of the exposure screen please see the corresponding section below Finally at the bottom of the main screen a series of control buttons are displayed They all have different informational or operational purposes and are described in details below 12 The Accidental Trader Game R amp R Consulting Inc Game Information The top part of the main screen shows general game information Here you can find contact information in case of technical issues the name of connected team and of the current game the current session and the current time step R amp R CONSULTING ACCIDENTAL TRADER GAME For any trouble or issue please contact dabitbol creditspectrum com Connected Team max Click here to log out Game Training Session 1 3 Month 6 12 A game will normally consist of three sessions In the example above Session Number 1 of a three session game is now in progress The same logic applies to the Month indicator i e there are twelve months in the session and we are now playing Month 6 Portfolio Parameters This is the most informative section of the user screen since it displays the main portfolio parameters The most important ones are shown in bold font Capital Structure Short Term Long Term Total 370 00 485 00 855 00 Portfolio Default Probabil
16. ing Works First let s see how teams playing the game get scores Team s score consists of two parts mentioned about in this manual how close portfolio probability of default was at every time step and what is total capital expense in other words how much did it cost to manage risks These two components are equally weighted by default but game administrator can changes the weights letting one of these factors influence total score more then other Portfolio probability of default at each time step should be close to a predetermined level normally 1 The further default probability goes from this level the worse team s performance and therefore the lower score There is no advantage of having portfolio default probability below this level Moreover it s absolutely equal in terms of scoring to have a portfolio with default probability of 2 and portfolio with default probability of 0 In this case both portfolios are one percent far from desired level of 1 There is another predetermined level for default probability in the game called Doomsday Team will be expelled from the current session when Doomsday level reached Expelled teams will be ranked lower then any other teams no matter what scores they got If there is more then one team expelled from the session the team which survived longer will receive a higher rank The Total Capital Expense is the second contributor to the final score The lower price paid for ma
17. ity Current Prior Doomsday 1 00 0 52 5 00 Portfolio Characteristics VaR Mean Loss Loss Standard Deviation 855 26 180 54 290 03 Additional Information Total Capital Expense Total Realized Losses Short Term Capital Cost 2 065 19 4 641 84 9 68 For instance the amount of Short Term Capital rented during the current month is displayed below the label Short Term As mentioned above STC and LTC taken together determine the portfolio s current probability of default Thus in the picture screen the total amount of capital available is 855 00 while current VaR is 855 26 This computes to a current probability of default of 1 which is the set point for the game Also a team can monitor its prior probability of default as well as the critical portfolio default probability beyond which it is expelled from the game In other words if a team s default probability rises above this level at any time during the game it will be expelled until the end of the session and will be allocated the highest expense level 13 The Accidental Trader Game R amp R Consulting Inc The next line shows Value at Risk VaR mean portfolio loss and portfolio loss standard deviation These statistical measures are used to evaluate the credit risk in the portfolio and derive its probability of default The final row in the table displays the Total Capital Expense one of the parameters used to determine a team s score Expense can be
18. l determine the amount of excess capital if any available to the lending team and then will transfer this excess amount to the renting team s account To enter into rental agreements teams can communicate with each other using their Skype account Each team needs a Skype account and a pair of earphones The Accidental Trader Game R amp R Consulting Inc User Interface How to Join the Game In order to join the game you will need to have a password enabling you to access the game server The password will usually be provided by the game administrator After logging into the server teams will be able to register their name with the system Below are detailed instructions on the registration step Each name needs to select a unique team identifier Game s Web Page First step is to visit our web site at http atg creditspectrum com The web site contains summary information about the game as well as a user manual available for download Click on the game screen shot or on the link Play The Game to go directly to the game server Server Login Connect to atg creditspectrum net PR z gt A The server atg creditspectrum net at R amp R CONSULTING SECURITY ACCESS requires username and password Warning This server is requesting that your username and password be sent in an insecure manner basic authentication without secure connection User name student Password
19. m can buy or sell protection on any exposure in its portfolio Buying protection in amount of LGD loss given default will result in total risk elimination for the particular exposure For example if LGD for a certain exposure is 55 then long CDS position of 55 will result in 0 expected loss On the other hand 100 long position in CDS will generate profits if the exposure defaults and this position is considered bearish Every exposure has its own CDS spread which changes with time and depends on how risky the exposure is Buying CDS protection will require pay monthly premium at the rate which was locked at the moment when contract was purchased Therefore after CDS protection was bought buyer will not be affected by changes in CDS spread CDS contract can be terminated at any time by entering into the opposite contract selling the same amount of protection which was bought In addition to that if an exposure has a CDS contract associated with it and team decides to trade it for one of the anti correlated exposures CDS contract will be automatically terminated In both cases termination value will be computed as a result of the future cash flaws discounted to the present This value can result in profit or loss which will be reflected on the Total Capital Expense Account 25 The Accidental Trader Game R amp R Consulting Inc Selling Protection Taking More Risk to Reduce the Cost of Capital Alternatively a team ca
20. n sell protection on any exposure in its portfolio This will increase the amount of expected loss for the exposure but on the other hand will bring profits realized from collecting CDS premium The amount of protection which can be sold is limited by the market Thus unlike buying protection a participant can sell only a certain amount of protection This amount specified on the exposure screen and changes with time The same termination rules apply to a short position in CDS contract It can be terminated manually by taking a long CDS position for the same exposure or trading the exposure In case if reference exposure defaults and team sold a CDS protection on it corresponding amount of protection sold and LGD of this exposure will be transferred to the Total Capital Expense account This amount usually will be significantly higher then regular interest payments or CDS premiums Therefore in case of such default team will be in a very bad condition in terms of expenses This will make most likely impossible to get high score in the game Renting Capital from Other Teams When capital rented from other teams instead of the market there are several aspects to consider First of all the amount which will be rented is not known until the beginning of the next time step As a result it s hard to estimate the amount of capital rented However lending team can give a rough estimation as to this amount looking at the current state of its portf
21. naging risks the higher score assigned to the team Therefore it s not a good strategy from the expense standpoint to buy protection on every exposure in the portfolio because premium paid for this protection will increase Capital Expense by a large amount The balance should be found by player in managing portfolio default probability and paying as little as possible for doing so Each session will have independent rankings for playing teams After all sessions played system will compute final game score and rankings of the participating teams based on results of each session played Never expelled teams will obtain highest ranks based on their scores After that expelled teams will be ranked based on how long they survived before being expelled and the total score they had achieved by that time 23 The Accidental Trader Game R amp R Consulting Inc Managing Probability of Default One of the main goals in the game is to keep portfolio default probability at each time step as close to the VaR target 1 by default as possible To achieve this playing team should have sufficient capital to keep their portfolio s default probability close to the target at all times This is not trivial task because exposures in portfolio change their default probabilities with time and consequently change portfolio characteristics This random nature of exposures makes close to impossible to predict exact amount of VaR at the next time step Howeve
22. ng term and short term accounts Long Term Capital Short Term Capital 308 72 gt 308 73 Confirm and Close The maximum total capital available at the outset is equal to your portfolio s current VaR This amount should be divided between Long Term and Short Term capital Remember that the amount of Long Term Capital you choose remains constant during the session As a general rule of thumb it is reasonable to dedicate about 80 of total capital to Long Term capital and to rent the rest as the game proceeds However depending on a strategy a team chooses this could be an under or overestimate After your capital structure has been set press the Confirm and Close button The system will wait until all teams have made their decision about the initial capital structure before proceeding to the next time step Therefore setting up the initial capital structure is the only required task during the first month of any session 10 The Accidental Trader Game R amp R Consulting Inc Main Screen Now let s look at the main screen which will be used by playing teams to obtain current information and make their decisions Before we proceed to the description of information and controls however we need to say a few words about the sub section of the main screen called World Events World Events At the beginning of each time step all teams will see this type of screen Observed changes results during t
23. ntal Trader Game R amp R Consulting Inc VaR VAR 950 900 850 800 750 700 650 600 4 5 t months Total Cost of Capital This graph shows the total dollar cost of managing credit risk As you can see on the picture Total Capital Expense can be negative which means that team realizes a credit profit while managing its credit risk Profits can be realized in a several ways As two obvious examples we can mention a Selling of CDS protection and collecting the premium and b Lending excess capital to other teams and receiving interest income Expense Meter Expense Meter 0 70 0 60 0 50 0 40 0 30 0 20 0 10 9 00 4 5 t months VaR shows the portfolio s Value At Risk metric as it evolves over time This may be useful when making tactical decisions One of the main tasks of a risk manager is to keep enough cash to cover VaR at all times For example on the graph at right VaR at time step 9 was 750 If the playing team had a total capital in the amount of 750 it would be considered a very efficient team at managing credit risk Total Capital Expense 500 500 1000 1500 2000 2500 3000 3500 4 5 t months To enable a quick comparison and an assessment of the game situation a global Expense Meter is shown on the main screen It shows the capital expense path only and a normalized numerical value of expenses
24. olio In this situation using Skype can become handy to negotiate with other teams about how much they will be able to lend at the beginning of next month System will determine automatically how much of the capital can be lent It will compute the excess amount of the lending team and transfer it to the Short Term Capital account of the renting team It s possible that that lending team will not have any excess capital In this case zero amount of capital will be transferred to the renting team and this team most likely will have real problems managing its portfolio s default probability After all renting capital from other teams provides a cheapest source of capital in the game However it also involves risks that lending team will not be able to provide any capital or will have too much capital to lend Therefore communicating with other teams is crucial to find the balance between needs and abilities of renting and lending teams 26
25. onding to the notional amount of the CDS contract At that moment the seller collects the last premium payment and the CDS contract is automatically terminated Participants can terminate any CDS contract by entering into an offsetting contract with identical terms In that case a termination value will be computed as of the current time step resulting in a profit or a loss on the position The Accidental Trader Game R amp R Consulting Inc Main State and Control Variables Capital The total amount of your capital directly linked with the default probability of your portfolio Therefore it is very important to have sufficient capital to cover your credit risk The total risk capital you have available consists of two parts Long Term Capital and Short Term Capital Long Term Capital LTC Before you start a new twelve round session you will have to decide how much Long Term capital you want to rent This amount cannot be higher than the portfolio s VaR at the beginning and will stay constant during the entire session The interest rate on Long Term capital is much lower than that on Short Term Capital Therefore it might make sense to rent as much Long Term capital as you think you might need to cover your VaR during the game However renting too much LTC at the beginning of a session can result if less flexibility during the session because you cannot adjust this capital during the session which is why it s called long te
26. onsulting Inc Sorting the table is convenient in cases where for example participants want to see the exposures with the highest default probabilities or else their current CDS position on said exposures As the default probability x changes over time the corresponding arrow will be shown next to the x value These arrows work the same way as those on the downgrade and upgrade screen mentioned earlier i e when the default probability goes down the arrow is green when it goes up it is red Control Buttons The set of control buttons at the bottom of the user screen allows the team to perform various actions and to obtain useful feedback information The Capital Management button brings up the screen where Short Term Capital can be rented from the market as well as traded with other teams The Scale button provides the relationship scale between probability of default and letter grade credit rating Portfolio Progress shows the prior evolution of various portfolio characteristics Capital Management Portfolio Progress Skype Refresh Portfolio World Events My last actions The Skype button has Skype IDs of all playing teams and helps to establish communication between them The Refresh Portfolio button is included to help players with older versions of web browsers If you believe that your portfolio table does not reflect the real picture for example just traded exposure is not in the portfolio please pre
27. or the team By analogy if team had sold a protection on exposure which later defaulted the protection amount will be added to the Total Expense account 24 The Accidental Trader Game R amp R Consulting Inc Trading Exposures Trading exposure provides participant with very efficient and inexpensive tool for managing portfolio risk Every month each team will be given a set of anti correlated to its portfolio exposures Any exposure in team s portfolio except defaulted ones can be traded Transaction costs will be added to the Total Expense account They are very low comparing to the amounts of money invested in exposures interest payments and CDS premiums Once exposure from the given set was chosen to trade it will replace original exposure in team s portfolio If original exposure had CDS protection associated with it the contract will be terminated and termination value will be added to the team s Total Capital Expense As mentioned above trading will be very helpful in cases when there are some extremely risky exposures in the portfolio make task of estimating the VaR for the next time step impossible Besides that team can set up some rules like Don t keep any exposure with default probability higher then 15 in the portfolio Trading will become very helpful to enforce such a rule Judicious and spare use of trading is what is intended Buying Protection Risk Elimination Alternatively to trading tea
28. positive or negative A negative expense means that profits were realized as a result of risk management Portfolio expenses include trading costs any CDS premia paid and received interest on rented capital and interest received from renting a team s excess available capital to other teams Expense Meter This graph shows the Expense Meter relative performance of all teams playing a game Depending on actions taken by every team and due toa max series of random world Te events the Expense Meter Martingale Speculator for each team will be _ associated with different values as time progresses The Expense value is cumulative therefore only 2 3 t months the last value is used when computing the final score metrics The graph s purpose is to give team members an idea of how they are doing during the session Based on this information a team can decide which actions if any to take in order to increase its risk management efficiency Portfolio The portfolio is represented via the exposure table Each exposure is displayed on a single row in the table Exposures can be sorted by Name Probability of Default x LGD Loss and associated CDS position To sort the table simply click on the corresponding label When the same label is clicked a second time the sorting order toggles between ascending and descending 14 The Accidental Trader Game R amp R C
29. r estimation can be made based on current value of VaR and looking on historical data for the whole portfolio Short Term capital provides flexibility for participants at every time step to address their expectation concerning VaR on the next time step Therefore staying close to 1 should not be a big problem for a regular portfolio In some cases portfolio can behave in a very volatile manner Usually it happens when several exposure in the portfolio have very low ratings high probabilities of default This can be fixed by trading these exposures for anti correlated ones As a result a whole portfolio can become less sensitive to the World Events and therefore VaR will be much easier to estimate Total Capital Expense The cost of managing risks accumulates on a special account named Total Capital Expense Every time capital is rented from the market or from the other team interest will be charge from this account including both Short and Long Term capital In addition to that when CDS protection purchased premium will be paid from this account every month Contrary if protection was sold realized premium will be transferred to this account as well as when excess capital lent to another team corresponding amount of interest will be transferred If exposure on which protection was bought defaults payment will be made by a protection seller depending on amount of protection sold This payment will decrease Total Capital Expense f
30. rate and the lending team will receive this payment reducing its total capital expense Please note that both forms of capital rental can be used simultaneously This means that a team can place a request to rent from the market and at the same time indicate its desire to trade with another team The amount rented from the market will be allocated to the team regardless of its other activities 17 The Accidental Trader Game R amp R Consulting Inc 1 AS Baal Baas Bal 1 B2 B3 Caal 2 Probability Of Default 0 000050 0 000100 0 000250 0 000750 0 001000 0 002500 0 007500 0 500000 1 250000 2 7 00000 5 000000 7 50000096 12 000000 17 500000 22 000000 30 000000 33 000000 47 000000 78 000000 100 000000 18 The Scale button acts as a source of additional information on how letter grade ratings derived from the probability of default For example in the table at right you can see that a Baa2 rating on average corresponds to a 1 25 annualized portfolio default probability Actual default probabilities in the game are unlikely to be exactly the same as those in the table In intermediate cases the game uses the geometric average bracketing two letter grade ratings to figure out which rating should be assigned to a particular exposure Normally a participan
31. rm If this amount is greater then the current VaR requirement you will not be able to adjust total capital in an effort to bring your probability of default to the desired level In that case you will be wasting capital Of course you can rent someone else s capital if you think that may help although doing so will tend to be expensive since your rental cost will depend on your previous default probability The idea is not to have too much or too little capital but just the right amount Short Term Capital STC Short Term capital is available for rent at the beginning of every month and it is always rented for a one month term Thus any amount of Short Term capital you have rented for the previous time step will be given back to the lender at the end of the month This form of capital gives participants the flexibility to address the current risk situation in the portfolio and adjust total capital as mentioned above Renting Capital At the beginning of each session participants will decide how much Long Term capital to secure After that only Short Term capital will be rented There are two ways to rent it First any amount of STC can be rented directly from the market at a given floating interest rate Second it can be rented from other participants In that case the interest rate will be lower than the market rate However the renting team will have no effective control over how much capital is available for rent The system wil
32. s decision rather than a mistake On the right corner of the screen players can see Traffic Lights These are not control buttons but simply provide information about the game s current status A green light means that players can make their decisions In this mode all buttons and screens are available to participants After the Ready button is pressed the light turns red indicating that the system is waiting for all teams to be ready to start processing information In this mode all buttons are disabled and teams may not take any action When all teams are ready and all requests have been processed by the system teams are presented with the information window previously shown the one that shows upgrades downgrades and defaulted exposures At that time the traffic light turns yellow This informs players that when the Confirm button on the information window is pressed they will be able to start making decisions the green mode that will affect the subsequent round 22 The Accidental Trader Game R amp R Consulting Inc Basic Game Concepts In this section of the manual we will cover the main basic game concept Each of them will concentrate on managing risk using one of the game components It is crucial to understand that these concepts taken alone will not lead to a good risk management strategy However they can be used as building blocks to create more sophisticated and robust strategy How the Scor
33. sible to rent capital from an expelled team Therefore if a team has been expelled its name will not appear in the list of available rental candidates This way of renting STC affords the renting team with a lower interest rate than the market rate However the amount of cash available for rent will be determined by the system before the beginning of the next round based on how much excess capital is then available to the lending team Thus the borrowing team cannot know beforehand the exact amount of capital that will be made available by the lending team Nevertheless this amount can be estimated by the lending team and communicated via Skype If you wish to rent from a certain team simply indicate that fact in the column labeled Rent next to the selected team s name The lending team should state its intentions by selecting the Lend box corresponding to its partner team name Before the following round the system looks at renting requests and matches those that correspond This means that a team s renting mechanism will be executed if and only if Team A has chosen to Rent from Team B and Team B has chosen to Lend to Team A during the same round If such a request is in place the system will determine the amount of excess capital available to the lending team if any and transfer this amount of capital to the renting team s account The renting team will pay interest for the amount transferred at its allocated
34. sk manager However taken together they determine the values of the main portfolio characteristics Exposure Even though a single exposure does not reflect much of the characteristics of a large portfolio it is still useful to know information about individual risks Usually a risk manager will be interested in monitoring the most risky components of the portfolio Therefore the game gives participants the ability to review individual exposures and take actions like trading and buying or selling protection This is how a manager can bring the whole portfolio to a desired risk level The game provides the following parameters displayed on the exposure screen portfolio table or both e Name Every exposure is assigned a unique identifier and a name The exposure s name doesn t carry any useful information and serves only to identify single loans in a more realistic context Thus the fact that an exposure is called Microsoft does not mean that it should have a high rating and therefore a low probability of default e Rating A Moody s letter grade rating is assigned to each exposure The rating is based on the probability of default The lower the probability of default for a certain exposure the higher the credit rating Ratings can change from one time step to another as a result of natural exposure evolution as well as from random world events Participant can observe current and previous ratings at any given time step e
35. ss this button and the latest information will be retrieved from the database The World Events button provides the log of all events that occurred during the current session The log file contains all upgrades and downgrades as well as all defaults with corresponding time step The My Last Actions button displays a history of all prior actions taking by a playing team These actions are recorded with their corresponding time step and other meaningful information Sometimes it can be helpful for players to see which actions have been taken as a guide to a better risk management strategy The Ready button when pressed lets the system know that a team has made all its current decisions and is ready to proceed to the next time step After a team presses this button changes to any parameter can only be made at the next time step In connection with this button it is crucial not to forget to rent Short Term Capital at every time step Also please note that the system will prompt each team if the amount of its requested Short Term Capital is zero At that moment the team can decide to change it or else proceed if this value is a conscious part of its current risk management strategy i e to rent zero Short Term Capital during the next time step This maneuver should only be done carefully 15 The Accidental Trader Game R amp R Consulting Inc Capital Management Using this screen participant can mange Short Term
36. t will not use this table explicitly Nevertheless it helps to establish an intuitive feeling between letter grades ratings and default probabilities The Accidental Trader Game R amp R Consulting Inc Portfolio Progress The Portfolio Progress button brings up a screen showing a time series of a team s benchmarks There are five graphs available on this screen We now briefly discuss each one below Average Portfolio Rating X t Average Portfolio Rating X t The Average Portfolio Rating represents 4 0 the average default probability of ae exposure in a team s portfolio It helps to visualize how the portfolio 3 4 evolves Is it too volatile Does Pd 3 2 increase or decrease in time Etc Knowing this information helps to estimate how much STC should be allocated to 2 6 an cover the team s portfolio credit risk for the t months next round 2 8 Probability of Default This graph shows the evolution of the Probability of Default portfolio s default probability given total 3 5 available capital in each round As you will recall every team s goal is to keep its portfolio default probability equal the set point usually 1 by renting capital 0 trading exposures etc 1 5 Therefore this graph shows how efficient a team is able to manage credit risk The more volatile this graph the worse the 0 0 ae team s performance t months 19 The Accide
37. ults that occurred during previous time steps Defaults usually don t happen often hence it is very likely for no default to have occurred during any given month However there can be time steps where a few defaults will occur in a single month Once a player presses the Confirm and Close button this informational screen disappears and the main control screen becomes fully functional 11 The Accidental Trader Game R amp R Consulting Inc Main Screen Overview Here is a typical main screen display It consists of several areas which we describe in detail below In general the most valuable information to a risk manager is displayed in the table in the top left corner Here a player can monitor important benchmarks associated with his or her current portfolio R amp R CONSULTING ACCIDENTAL TRADER GAME cr ave please corean dabezolgcredespacrum com On the right of the table a graph labeled Expense Meter is displayed It shows the comparative performance of all teams playing a given game As is implied by the graph s label the lower a team is positioned on the graph the better it is currently performing Players can see all historical changes from the beginning of the session time 0 until the current time step The large section underneath the graph and the parametric table shows the team s current portfolio Participants will see all exposures in the portfolio as well as their ma
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