the accidental trader user manual

8/2/2019 The Accidental Trader User Manual

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The Accidental Trader Game

R&R Consulting Inc.

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THE ACCIDENTAL TRADER GAME

R&R Consulting

2007

http://atg.creditspectrum.net


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INTRODUCTION. ....................................................................................................................................... 3

MAIN ELEMENTS OF THE GAME......................................................................................................... 4

PORTFOLIO.................................................................................................................................................. 4

EXPOSURE................................................................................................................................................... 4

Ratings. .......... ........... ......... ........... ......... ........... .......... .......... .......... .......... ........... ......... ........... ......... ..... 5

Trading. ................................................................................................................................................. 5

Buying and Selling Protection. .......... ......... ........... ......... ............ ......... ........... ............ ......... ........... ....... 5

CAPITAL...................................................................................................................................................... 7

Long Term Capital. .......... ........... ......... ............ ......... ........... ......... ........... ......... ........... .......... .......... ...... 7

Short Term Capital. ............................................................................................................................... 7

Renting Capital. ......... .......... .......... ........... ......... ........... ......... ............ ........... ......... ........... ......... ............ 7

USER INTERFACE. .................................................................................................................................... 8

MAIN SCREEN. ...........................................................................................................................................10

Game Information. ................................................................................................................................12

Portfolio Parameters. ...........................................................................................................................13

Expense Meter. ............. .......... ........... ......... ........... ......... ............ ......... ........... ............ ......... ........... ......14

Portfolio. ...............................................................................................................................................14

Control Buttons. ....................................................................................................................................15

CAPITAL MANAGEMENT. ...........................................................................................................................16

Interest Rates. ........... ......... ........... ......... ........... .......... .......... .......... .......... ........... ......... ........... ......... ....16

Renting From The Market. .......... ......... ............ ......... ........... ......... ........... ......... ........... .......... .......... .....17

Renting From Other Teams. ................ ........... .......... ........... ......... ........... ......... ........... .......... .......... .....17

SCALE. .......................................................................................................................................................18PORTFOLIO PROGRESS. ..............................................................................................................................19

Average Portfolio Rating X(t). ........... ......... ........... ......... ............ ......... ........... ............ ......... ........... ......19

Probability Of Default. .........................................................................................................................19

VaR. ......................................................................................................................................................19

Total Cost Of Capital. .......... .......... ........... ......... ........... ......... ............ ........... ......... ........... ......... ...........20

SKYPE. .......................................................................................................................................................21

WORLD EVENTS. ........................................................................................................................................21

LAST ACTIONS. ..........................................................................................................................................21

READY BUTTON AND TRAFFIC LIGHT. .......................................................................................................22

BASIC GAME STRATEGIES. ..................................................................................................................23

HOW THE SCORING WORKS. ......................................................................................................................23

MANAGING PROBABILITY OF DEFAULT. ....................................................................................................25THE COST OF CAPITAL. .............................................................................................................................25

TRADING EXPOSURES. ...............................................................................................................................26

BUYING PROTECTION RISK ELIMINATION. ..............................................................................................26

SELLING PROTECTION TAKING MORE RISK TO REDUCE THE COST OF CAPITAL. ...................................28

RENTING CAPITAL FROM OTHER TEAMS. ..................................................................................................28


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Introduction

The Accidental Trader Game is an educational tool designed to simulate the real-lifeexperience of a risk officer or trader managing the credit risks of a large portfolio ofcorporate bond or loan exposures.

Delegates have an opportunity to manage a large portfolio undergoing multi-period creditchallenges by adopting various credit risk management strategies to keep the portfolioprobability of default [Pd] at a pre-determined value, which the game administrator hasset using a corresponding Value at Risk (VaR) level. In addition, the teams portfoliodefault 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, haslost the ability to control the portfolio. That outcome corresponds in practice to economicloss for the firm and probable job loss for the manager. The game ends after a certainnumber of time periods, usually twelve, or when each team but the last - the winningteam - is out of business. If more than one team survives, the team with the best Pdrecord is declared the winner [statistic factor], while other teams are ranked by theirlongevity in the game [stochastic factor].

At the beginning of the game, each team is provided with an initial portfolio of riskyexposures. All exposures are assigned a credit rating reflecting its ex-ante probability ofdefault. Associated with each risky exposure, is a set of financial characteristicscommonly used as input variables in credit risk modeling and management, such as therecovery rate, loan-equivalent exposure and credit-default swap [CDS] spread. Those

characteristics change with the passage of time and trigger various credit events such asupgrades, downgrades and defaults, which are reported at the beginning of each timestep or round. So are key portfolio-level parametric averages: portfolio mean loss,portfolio loss standard deviation, and VaR to help managers in forming risk judgmentsand making tactical portfolio adjustments.

At the beginning of each time step, teams borrow short-term funds from the market orone another in order to keep the portfolio probability of default at the target level. Thegame is not designed to create a portfolio whose value will increase secularly over time,the way a trader might view the credit problem. This is strictly about credit riskmanagement, not credit risk speculation. Although the up side is always much moreattractive in the stock market for instance, credit risk professionals are much more

focused on the down side, hence the essence of the game. Teams can improve theirperformance through various risk-management tactics. They can swap out of riskyexposures for anti-correlated equivalents to reduce portfolio sensitivity to extremeevents, or buy or sell CDS contracts on their portfolio exposures. By doing so, teams canrealize gains or losses as well as increase or decrease their exposure to the market.


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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 portfolioconsists of the set of N risky exposures, whereby N is arbitrary. Each exposure takenalone does not carry much information for the risk manager. However, taken togetherthey determine the values of the main portfolio characteristics.

Exposure

Even though a single exposure does not reflect much of the characteristics of a largeportfolio, it is still useful to know information about individual risks. Usually, a riskmanager will be interested in monitoring the most risky components of the portfolio.Therefore, the game gives participants the ability to review individual exposures andtake actions, like trading and buying or selling protection. This is how a manager canbring the whole portfolio to a desired risk level.

The game provides the following parameters, displayed on the exposure screen,portfolio table or both:

Name. Every exposure is assigned a unique identifier and a name. Theexposures name doesnt carry any useful information and serves only to identifysingle loans in a more realistic context. Thus, the fact that an exposure is calledMicrosoft does not mean that it should have a high rating and therefore, a lowprobability of default.

Rating. A Moodys letter-grade rating is assigned to each exposure. The rating isbased on the probability of default. The lower the probability of default for acertain exposure, the higher the credit rating. Ratings can change from one timestep to another as a result of natural exposure evolution, as well as from randomworld events. Participant can observe current and previous ratings at any giventime step.

Probability of default. One of the most important exposure characteristics. It isused to compute the likelihood that an exposure will default, its credit rating andits CDS spread. It also changes naturally as time passes based on the behaviorof an arbitrary driving function y(t) and sometimes randomly jumps up or down asa result of world events generated by the system [a Levi-jump process]. Historicaldata describing probability of default x(t) and the driving function y(t) aredisplayed on the exposure screen as well.

Loan Equivalent Exposure (LEE). This variable shows the dollar amount investedin each exposure. For the sake of simplicity, LEE is assumed to be constant


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across all portfolio exposures. The LEE amount influences the loss/profit profilein case of credit events, as well as CDS premia received or paid. 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, whendefault occurs.

CDS Spread. Annual premium received or paid for protection on any givenexposure. The more risky the exposure, the higher its CDS spread. The spreadchanges with time depending on the exposures system-computed probability ofdefault to reflect market conditions. For the sake of simplicity, we assume thatthe bid/ask spread is zero.

As a result of a credit event or a natural evolution every exposure can default. Defaultedexposures stay in the original holders portfolio but are no longer used to compute riskcharacteristics. It is also not possible to trade an exposure after it has defaulted, buy andsell protection on it or do any other operation available with respect to the non-defaultedexposures. The loss in the event of default is added to the Total Realized Lossesaccount and displayed in real time on the teams main screen.

Ratings

Letter-grade ratings are directly connected to the exposures probability of default, whichitself 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 forinformational 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 possibletrading candidates will be available to all teams. These choices consist of exposuresanti-correlated to the portfolio as a whole. There is a small transaction cost involved intrading, but in general it does benefit the risk manager to replace a highly risky exposurewith 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 lower. Consequently, less short-term capital will be needed and lower interest payments will be made to those whoprovide such capital, thus decreasing the total cost of risk management. If a managerhas bought or sold protection on the traded exposure, the said CDS contract will beautomatically terminated upon trade execution.

Buying and Selling Protection

Every participant can buy or sell protection on any exposure in the portfolio. Buyingprotection will attract a known premium every month based on the annual CDS spreadfor the target exposure. The notional amount of protection purchased or sold is selectedas an arbitrary percentage of the exposures loan-equivalent exposure. Therefore, to


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fully protect an exposure, a notional amount equal to LGD should be purchased. On theother hand, any amount of CDS notional can be purchased. If the exposure defaults, theprotection buyer will receive the corresponding LEE amount and the CDS contract willbe terminated.

Protection can also be sold on the open market. However, the amount of protectionwhich can be sold is limited by market interest. As a result of selling protection via aCDS contract, the seller will collect monthly premiums but will have higher expectedlosses, which will increase the selling teams capital requirements. If a credit eventoccurs and the target exposure defaults, the seller will have to pay the amountcorresponding to the notional amount of the CDS contract. At that moment, the sellercollects the last premium payment and the CDS contract is automatically terminated.

Participants can terminate any CDS contract by entering into an offsetting contract withidentical terms. In that case, a termination value will be computed as of the current timestep, resulting in a profit or a loss on the position.


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Main State and Control Variables

Capital

The total amount of your capital directly linked with the default probability of yourportfolio. 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 andShort Term Capital.

Long Term Capital [LTC]

Before you start a new, twelve-round session, you will have to decide how much LongTerm capital you want to rent. This amount cannot be higher than the portfolios VaR atthe beginning and will stay constant during the entire session. The interest rate on LongTerm capital is much lower than that on Short Term Capital. Therefore, it might makesense to rent as much Long Term capital as you think you might need to cover your VaRduring the game. However, renting too much LTC at the beginning of a session canresult if less flexibility during the session, because you cannot adjust this capital duringthe session, which is why its called long-term. If this amount is greater then the currentVaR requirement, you will not be able to adjust total capital in an effort to bring yourprobability of default to the desired level. In that case, you will be wasting capital. Ofcourse, you can rent someone elses capital if you think that may help, although doing so

will tend to be expensive since your rental cost will depend on your previous defaultprobability. 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 alwaysrented for a one-month term. Thus, any amount of Short Term capital you have rentedfor the previous time step will be given back to the lender at the end of the month. Thisform of capital gives participants the flexibility to address the current risk-situation in theportfolio and adjust total capital as mentioned above.

Renting Capital

At the beginning of each session, participants will decide how much Long Term capital tosecure. 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, floatinginterest rate. Second, it can be rented from other participants. In that case, the interestrate will be lower than the market rate. However, the renting team will have no effectivecontrol over how much capital is available for rent. The system will determine theamount of excess capital, if any, available to the lending team and then will transfer thisexcess amount to the renting teams account. To enter into rental agreements, teamscan communicate with each other using their Skype account. Each team needs a Skypeaccount and a pair of earphones.


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User Interface

How to Join the Game

In order to join the game, you will need to have a password, enabling you to access thegame server. The password will usually be provided by the game administrator. Afterlogging into the server, teams will be able to register their name with the system. Beloware detailed instructions on the registration step. Each name needs to select a uniqueteam-identifier.

Games Web Page

First step is to visit our web siteat:http://atg.creditspectrum.com

The web site contains summaryinformation about the game, aswell as a user manual availablefor download.

Click on the game screen-shot

or on the link Play The Gameto go directly to the gameserver.

Server Login

Now, you will need a log-in name and apassword to login to the server. Thisinformation will be provided to you by thegame administrator.

This process will let you log in to the server notto the particular game. Usually, all participantswill have the same name and password at thisstep.

After logging into the server, each team willhave an ability to choose which game to play,register itself, continue playing a previousgame, etc.


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Join the Game

If you have registered yourteam before, now is the time to

join one of the new games.Type your teams name,password, and choose a gamefrom the drop down box.

Ask the administrator whichgame was created for you. Ifthe name of this game does not

appear on the list, please clickthe refresh games list buttonbelow. Once ready, press thesubmit button.

Creating New Account

If you havent registered yourteam yet, click on the Clickhere to register link. Theregistration form will come up.Please, provide all requiredinformation, including Skype id,which is important for you andother teams to be ablecommunicate during the game.

After that, click on the registerbutton. A confirmation screenwill be displayed. Now, yourteam can join any new gamefrom the log in screen.

Re-Joining the Last Game

The first item in the game drop-down box will be [last game]. Players should choosethis item if they wish to continue playing the previous game they were playing, andstopped playing for some reason. If that game is still running you can easily join backand start right from the place you stopped. This feature is useful in case the teams webbrowser or computer had to be rebooted, or if the game was postponed for a period oftime, such as lunch.


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Initial Capital Setup

Before beginning any new session, participating teams will be asked to set up theircapital structure. As mentioned above, this will consist of two parts: Long Term- andShort Term Capital. The capital setup screen is shown below:

The maximum total capital available at the outset is equal to your portfolios current VaR.This amount should be divided between Long Term- and Short Term capital. Rememberthat 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 toLong Term capital and to rent the rest as the game proceeds. However, depending on astrategy a team chooses, this could be an under- or overestimate.

After your capital structure has been set, press the Confirm and Close button. Thesystem will wait until all teams have made their decision about the initial capital structurebefore proceeding to the next time step. Therefore, setting up the initial capital structureis the only required task during the first month of any session.


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Main Screen

Now, lets look at the main screen which will be used by playing teams to obtain currentinformation and make their decisions. Before we proceed to the description ofinformation and controls however, we need to say a few words about the sub-section ofthe main screen called World Events.

World Events

At the beginning of each time step, all teams will see this type of screen:

It informs players about what happened in the games world during the past month. Thetop part of the screen shows upgrades and downgrades. Upgrades are indicated bygreen, down-arrow symbols. The direction of the arrow means that the probability ofdefault went down, hence the green (improvement) color. On the other hand, when anexposures default probability went up, a red (deterioration) arrow is displayed.

Participants will also be able to see the name of each upgraded/downgraded exposureand how its letter-grade credit rating has changed.

The screen section beneath upgrades and downgrades shows defaults that occurredduring previous time steps. Defaults usually dont happen often; hence, it is very likelyfor no default to have occurred during any given month. However, there can be timesteps where a few defaults will occur in a single month.

Once a player presses the Confirm and Close button, this informational screendisappears and the main control screen becomes fully functional.


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Main Screen Overview

Here is a typical main screen display. It consists of several areas which we describe indetail below. In general, the most valuable information to a risk manager is displayed inthe table in the top left corner. Here, a player can monitor important benchmarksassociated with his or her current portfolio.

On the right of the table, a graph labeled Expense Meter is displayed. It shows thecomparative performance of all teams playing a given game. As is implied by the graphslabel, 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 thecurrent time step.

The large section underneath the graph and the parametric table shows the teamscurrent portfolio. Participants will see all exposures in the portfolio as well as their maincharacteristics (see above). To obtain more detailed information about particularexposures, 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. Theyall have different informational or operational purposes and are described in detailsbelow.


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Game Information

The top part of the main screen shows general game information. Here, you can findcontact information in case of technical issues, the name of connected team and of thecurrent game, the current session and the current time step.

A game will normally consist of three sessions. In the example above, Session Number1 of a three-session game is now in progress. The same logic applies to the Monthindicator, 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 portfolioparameters. The most important ones are shown in bold font.

For instance, the amount of Short Term Capital rented during the current month isdisplayed below the label Short Term. As mentioned above, STC and LTC takentogether determine VaR, which in turn determines the portfolios current probability ofdefault. Thus, in the picture screen, the total amount of capital available is $855.00 whilecurrent VaR is $855.26. This computes to a current probability of default of 1%, which isthe set point for the game. Also, a team can monitor its prior probability of default as wellas the critical portfolio-default probability beyond which it is expelled from the game. Inother words, if a teams default probability rises above this level at any time during thegame, it will be expelled until the end of the session and will be allocated the highestexpense level.


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The next line shows Value at Risk (VaR), mean portfolio loss, and portfolio loss standarddeviation. These statistical measures are used to evaluate the credit risk in the portfolioand derive its probability of default.

The final row in the table displays the Total Capital Expense one of the parametersused to determine a teams score. Expense can be positive or negative. A negativeexpense means that profits were realized as a result of risk management. Portfolioexpenses include trading costs, any CDS premia paid and received, interest on rentedcapital, and interest received from renting a teams excess available capital to otherteams.

Expense Meter

This graph shows therelative performance of allteams playing a game.Depending on actions takenby every team and due to aseries of random world-events, the Expense Meterfor each team will beassociated with differentvalues as time progresses.The Expense value is

cumulative, therefore onlythe last value is used whencomputing the final score.

The graphs purpose is to give team members an idea of how they are doing during thesession. Based on this information, a team can decide which actions, if any, to take inorder to increase its risk management efficiency.

Portfolio

The portfolio is represented via the exposure table. Each exposure is displayed on asingle 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 thecorresponding label. When the same label is clicked a second time, the sorting ordertoggles between ascending and descending.


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Sorting the table is convenient in cases where, for example, participants want to see theexposures with the highest default probabilities or else their current CDS position on saidexposures. As the default probability [x] changes over time, the corresponding arrow willbe shown next to the x value. These arrows work the same way as those on thedowngrade and upgrade screen mentioned earlier, i.e. when the default probability goesdown, 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 performvarious actions and to obtain useful feedback-information. The Capital Managementbutton 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 scalebetween probability of default and letter-grade credit rating. Portfolio Progress showsthe prior evolution of various portfolio characteristics.

The Skype button has Skype IDs of all playing teams and helps to establishcommunication between them. The Refresh Portfolio button is included to help playerswith older versions of web browsers. If you believe that your portfolio table does notreflect the real picture (for example just traded exposure is not in the portfolio), pleasepress 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 currentsession. The log file contains all upgrades and downgrades, as well as all defaults withcorresponding time step.

The My Last Actions button displays a history of all prior actions taking by a playingteam. These actions are recorded with their corresponding time step and othermeaningful information. Sometimes, it can be helpful for players to see which actionshave 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 itscurrent decisions and is ready to proceed to the next time step. After a team presses thisbutton, 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 atevery time step. Also, please note that the system will prompt each team if the amount ofits requested Short Term Capital is zero. At that moment, the team can decide to changeit or else proceed if this value is a conscious part of its current risk managementstrategy, i.e. to rent zero Short Term Capital during the next time step. This maneuvershould only be done carefully.


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Capital Management

Using this screen participantcan mange Short Termcapital.

The small graph on the righthand side shows interestrates. The green lineindicates Long Term Capitalinterest rate, which is

constant over the course ofthe game.

The blue line representsShort Term Capital interestrate, which changes fromone time step to another.

Any player can communicatewith other players using theSkype buttons placed infront of team names in the

table below.

As mentioned before, there are two ways to obtain Short Term Capital, i.e. from themarket 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. Itsalways higher than the long term rate and intimately tied to the teams portfolio defaultprobability. Normally, when a teams default probability rises, this rate will increase andconversely, when the default probability decreases, the rate decreases.

Long Term capital is a much cheaper source of capital. However, it lacks the flexibilityprovided by Short Term Capital. Therefore, it is a good idea to wisely allocate an optimalamount of Long Term Capital at the beginning of every session. Participants should becareful when making a decision about this allocation. For instance, allocating too muchLong Term Capital can lock in a teams total capital amount at a relatively high level, andhence prevent the portfolios probability of default from being maintained at the desiredlevel. This means that the portfolio default probability will be too low even with zero ShortTerm Capital allocation. Conversely, allocating too little may lead to a higher total cost ofcapital, and therefore, to abnormally high total capital expenses.


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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 capitalmanagement screen next to the Amount, $ field and on the associated graph. Anydesired positive amount of Short Term capital can be requested and obtained from themarket. To do so, simply enter the amount you need on the Capital Management screenand press the Confirm button. Be careful while making a decision about the amountyou need. Renting too little can lead to a very high portfolio default probability, whichmeans that your portfolios default probability would exceed the Doomsday value,leading to your expulsion from the session. If that happens, you will not be able tocontinue 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 participatingteams. Please note that it is not possible to rent capital from an expelled team.Therefore, if a team has been expelled, its name will not appear in the list of availablerental candidates.

This way of renting STC affords the renting team with a lower interest rate than themarket rate. However, the amount of cash available for rent will be determined by thesystem before the beginning of the next round based on how much excess capital isthen available to the lending team. Thus, the borrowing team cannot know beforehandthe exact amount of capital that will be made available by the renting team.Nevertheless, this amount can be estimated by the lending team and communicated viaSkype.

If you wish to rent from a certain team, simply indicate that fact in the column labeledRent next to the selected teams name. The lending team should state its intentions byselecting the Lend box corresponding to its partner-team name.

Before the following round, the system looks at renting requests and matches those thatcorrespond. This means that a teams renting mechanism will be executed if and only ifTeam A has chosen to Rent from Team B and Team B has chosen to Lend to TeamA 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 amountof capital to the renting teams account. The renting team will pay interest for the amounttransferred at its allocated rate and the lending team will receive this payment, reducingits 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, indicateits desire to trade with another team. The amount rented from the market will beallocated to the team regardless of its other activities.


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ScaleThe Scale button acts as asource of additional informationon how letter-grade ratingsderived from the probability ofdefault.

For example, in the table atright, you can see that a Baa2rating, on average, correspondsto a 1.25% annualized portfolio

default probability.

Actual default probabilities inthe game are unlikely to beexactly the same as those in thetable. In intermediate cases, thegame uses the geometricaverage bracketing two letter-grade ratings to figure out whichrating should be assigned to aparticular exposure.

Normally, a participant will notuse this table explicitly.Nevertheless, it helps toestablish an intuitive feelingbetween letter-grades ratingsand default probabilities.


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Portfolio Progress

The Portfolio Progress button brings up a screen showing a time series of a teamsbenchmarks. There are five graphs available on this screen. We now briefly discusseach one below.

Average Portfolio Rating X(t)

The Average Portfolio Rating representsthe average default probability of allexposure in a teams portfolio.

It helps to visualize how the portfolioevolves. Is it too volatile? Does Pdincrease or decrease in time? Etc.

Knowing this information helps to estimatehow much STC should be allocated tocover the teams portfolio credit risk for thenext round.

Probability of Default

This graph shows the evolution of theportfolios default probability given totalavailable capital in each round. As you willrecall, every teams goal is to keep itsportfolio default probability equal the setpoint (usually 1%) by renting capital,trading exposures, etc.

Therefore, this graph shows how efficient ateam is able to manage credit risk. The

more volatile this graph, the worse theteams performance.


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VaR

VaR shows the portfolios Value At Riskmetric as it evolves over time. This may beuseful when making tactical decisions.

One of the main tasks of a risk manager isto keep enough cash to cover VaR at alltimes.

For example, on the graph at right, VaR at

time step 9 was $750. If the playing teamhad a total capital in the amount of $750, itwould be considered a very efficient teamat managing credit risk.

Total Cost of Capital

This graph shows the total dollar cost ofmanaging credit risk. As you can see onthe picture, Total Capital Expense can benegative, which means that team realizesa 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 collectingthe premium and,b) Lending excess capital to other teamsand receiving interest income.

Expense Meter

To enable a quick comparison and anassessment of the game situation, a globalExpense Meter is shown on the mainscreen. It shows the capital expense pathonly and a normalized numerical value ofexpenses.

Using this graph, players can evaluatetheir performance from one time step tothe next, and potentially correct theirstrategies. Thus, the expense meter canbe regarded as the main game benchmark.


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Skype

The Skype button acts as a smallcommunication center, providing the list of allplaying teams and their Skype IDs.

Players will need to use Skype to make verbalcapital trading agreements with each other.

The Status field shows whether a team isavailable 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 ofthis log have are shown to participants before every round. Therefore, the purpose ofthis screen is to provide players with additional historical information about WorldEvents.

World Events occur randomly. Nevertheless, there is logic behind this randomness.Thus, its very unlikely that an exposure rated AAA would ever default. However, insome rare cases an exposure rated AA will be made to default. This can happen in thereal 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 thesession. Every action has a corresponding time step. This information can be used to


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refresh your memory on which actions were taken previously and to see how theyaffected 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 bepressed when a team made all the decisions for current time step. Once pressed, thereis no recourse. Its very important not to forget to rent Short Term Capital (when itsneeded, of course) before pressing the Ready button. Therefore, the system checks if

Short Term Capital was rented from the market. If it wasnt, the system asks the playeror team to confirm positively that not renting an STC was a conscious decision ratherthan a mistake.

On the right corner of the screen, players can see Traffic Lights. These are not controlbuttons, but simply provide information about the games 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 iswaiting for all teams to be ready to start processing information. In this mode, all buttonsare disabled and teams may not take any action.

When all teams are ready and all requests have been processed by the system, teamsare presented with the information window previously shown, the one that showsupgrades, downgrades and defaulted exposures. At that time, the traffic light turnsyellow. This informs players that, when the Confirm button on the information window ispressed, they will be able to start making decisions (the green mode) that will affect thesubsequent round.


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Basic Game Concepts

In this section of the manual, we will cover the basic game concepts. Each of them willconcentrate on managing risk using one of the games components. It is crucial tounderstand that these concepts, taken in isolation, may not necessarily lead to a goodrisk management outcome. However, they can be used as building blocks to createmore sophisticated and robust strategies.

How the Scoring Works

First, lets see how teams score points. A given teams total score consists of the twocomponents mentioned elsewhere in this document. Briefly, they are:

1) How close the portfolios default probability came to the set point (see below)at every round.

2) What was total capital expended to achieve the above probabilistic result. Inother words, how much did it cost to manage your portfolios credit risk?

Initially, both components are equally weighted. However, the game administrator canchange the weights. This allows one of the above factors to influence the teams score toa greater degree than the other.

The portfolios default probability at each time step should be close to the set point,normally 1%. The further the default probability departs from this level, the worse theteams performance and therefore the lower the score. There is no advantage to havingthe default probability below the set point. Moreover, there is no credit given to teamsevidencing default probabilities lower than the set point, compared to those with defaultprobabilities higher than the set point. For instance, a team with a portfolio defaultprobability of 2% and another one with a probability of 0% would be scored the samebecause, in both cases, the probability is one percent away from the set point of 1%.

The game contains another critical default probability level called the Doomsday level.Teams will be expelled from the current session when its portfolio default probabilityreaches the Doomsday value. Expelled teams will be ranked lower then any other team

in the game no matter what score they currently register. If more than one team isexpelled from the session, the team which survived the longer will receive the higherrank.

The Total Capital Expense is the second contributing factor to a teams final score. Thelower the price paid for managing its credit risk, the higher the value of the associatedcomponent in the final score. Therefore, it is not a good strategy from the expensestandpoint to buy protection on every exposure in the portfolio, in an obvious and naveattempt to forestall all consequences of default, because the premia paid for thisprotection would increase the Total Capital Expense by a large amount. In general, ahappy medium should be found by managing the portfolios default probability andpaying as little as possible for doing so. This is the secret of winning the game.


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Each session is independent of any other session with respect to team scoring. After allsessions are completed, the system will compute the final game score and rank theparticipating teams based on the combined results of all sessions. Teams that werenever expelled will be ranked based solely on their scores. Thereafter, teams that wereexpelled at least once will be ranked based on how many times they were expelled, howlong they survived until expulsion and the score they had achieved at that time.


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Managing the Portfolios Default Probability

As mentioned above, the games main goal is to keep the portfolios default probability atevery time step close to VaR precision level (1% by default). To achieve this, playingteams should have sufficient capital at all times for their default probability to be close tothat implied by their VaR. This is not a trivial task, because portfolio exposures are madeto undergo a largely random, but somewhat deterministic credit risk path that changestheir individual default probability at each round, consequently changing portfoliocharacteristics.

The random nature of exposure credit risk makes it close to impossible to predict the

exact amount of VaR needed at the next time step to keep Pd equal to 1%. However, arough estimation can be made based on the current VaR value and by looking athistorical data on the whole portfolio.

As we saw previously, the possibility to change Short Term Capital affords participantssome flexibility in addressing their expectation of what VaR will be. Therefore, stayingclose to 1% should not be a big problem for a standard portfolio.

In some cases, the portfolio can behave in a very volatile manner. Usually, this happenswhen several exposures in the portfolio have very low ratings (high probabilities ofdefault). This can be addressed by trading these exposures for anti-correlated ones. Asa result, the entire portfolio becomes less sensitive to World Events. As a result, VaR

becomes much easier to estimate and therefore, controlling the portfolios defaultprobability also becomes easier.

Total Capital Expense

The cost of managing risks accumulates within a special account labeled Total CapitalExpense. Every time capital is rented from the market, or from other teams, interest willbe charged to this account, including both STC and LTC.

In addition, when CDS protection is purchased, the premium will be paid from thisaccount every month. Conversely, if protection was sold, the realized premium will betransferred to this account. Last, when excess capital is lent to other teams, thecorresponding interest earnings will show up in that account.

If an exposure on which protection was bought defaults, the payment will be made bythe protection seller depending on notional amount of the CDS contract. This paymentwill decrease the Total Capital Expense for the team by the same amount. By contrast, ifa team has sold protection on an exposure which later defaults, the notional protectionamount is added to the Total Expense account.


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Trading Exposures

Trading exposures provides a participating team with a very efficient and inexpensivetool for managing portfolio credit risk. Every month, each team will be offered a set ofexposures that are deemed anti-correlated to its own portfolio exposures. Any exposurein the teams portfolio, except defaulted ones of course, can be traded in this manner.Transaction costs will be added to the Total Expense account. They are very lowcomparing to the amounts of money invested in the exposures, interest payments andCDS premia.

Once exposure from the given set is chosen as a trading target, it replaces the original

exposure in the teams portfolio. If CDS protection was purchased previously on theoriginal portfolio exposure that is traded, the contract is terminated and the CDStermination value is added to the teams Total Capital Expense. The same procedureapplies when protection was sold on the target exposure. As mentioned above, tradingwill be very helpful in cases when the portfolio contains some extremely risky exposuresthat make the task of estimating the VaR on the next time step practically impossible.

Clearly, a team can always set up its own heuristic trading rules, like Dont keep anyexposure with a default probability higher then 15% in the portfolio. Trading becomes amust have feature if such rules are to be enforced. However, the games main goal isnot to trade exposures trying to stay away from all possible defaults. Rather, judicious aand spare use of trading is what is intended, hence the name of accidental trader

Buying Protection Risk Elimination

As an alternative, to trading, a team can always buy or sell protection on any exposure inits portfolio. Buying protection for a notional amount equal to LGD (loss given default)will result in total risk elimination for the particular exposure. For example, if the LGD ona certain exposure is 55%, then a long CDS position of 55% would result in $0 realizedloss in the event of actual default. On the other hand, a 100% long position in CDSwould generate a 45% profit if the exposure defaults. Thus, this position is consideredbearish.

Every exposure has its own CDS spread which changes over time, and which dependson how the credit risk of the exposure as measured by its numerical credit rating. BuyingCDS protection requires a monthly premium at the market rate shown at the time theCDS contract is consummated. Therefore, after CDS protection is bought, a buyer is nolonger affected by changes in CDS spread.

A CDS contract can be terminated at any time by entering into the opposite contract, forinstance by selling the same amount of protection that was bought earlier. In additionand as mentioned above, if an exposure already has a CDS contract associated with it,and the team decides to trade it for one of the anti-correlated exposures, the said CDScontract will be terminated automatically. In both cases, the termination value will becomputed based on discounting the future cash flows to present. All CDS maturities are


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assumed to be equal to the number of rounds remaining until a given sessionterminates, i.e. no CDS contract is allowed to survive the current session. Thisprocedure will result in a profit or a loss that will then be reflected on the Total CapitalExpense Account.


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Selling Protection Taking More Risk to Reduce the Cost ofCapital

Alternatively, a team can sell protection on any exposure in its portfolio. This obviouslyincreases the loss amount on the target exposure should it subsequently default. On theother hand, it also turns in an extra profit from collecting the associated CDS premium.As is true in life however, the amount of protection that can be sold is limited by themarkets ability to absorb the volume. Thus, unlike for buying protection, a participatingteam is only allowed to sell protection to an extent computed by the system. This amountis specified on the exposure screen and changes with time.

The same termination rules apply to a short position in the CDS market. It can beterminated manually by taking an off-setting long position on the same exposure, or elseby trading the exposure.

In case the reference exposure defaults and the team sold CDS protection on it, thecorresponding amount of protection sold and the LGD of this exposure will betransferred to the Total Capital Expense account. This amount will usually besignificantly higher then the regular interest payments or CDS premia. In case thishappens, the penalized team will suffer significantly in terms of its ability to win thesession. In practice, this will make it next to impossible to win the game. This feature isalso true to life, in that credit managers trying to earn additional yield via speculation cansuffer the consequences dearly.

Renting Capital from Other Teams

When capital is rented from other teams instead of the market, there are several aspectsto consider. First, the amount that will be actually rented is not known until the beginningof the next time step. As a result, it is difficult to estimate this amount for budgetingpurposes. However, a lending team can make a rough estimate by looking at the currentstate of its portfolio. In this situation, Skype can become a handy tool for negotiating withother teams on how much Short Term Capital they feel they will have available for rentat the beginning of the next round.

The system will determine automatically how much capital can be borrowed. It will firstcompute the excess short-term capital available to a lending team that has made a priorrental agreement with a borrowing team, and transfer that amount to the Short TermCapital account of the borrowing team. In this process, it is possible that that a lendingteam will not have any excess capital for rent. In this case, no capital will be transferredto the renting teams account and this team will most likely have a real problemmanaging its portfolios default probability.

As you know by now, renting capital from other teams provides the cheapest source ofcapital in the game. However, it also involves the risk that the lending team will not beable to provide any capital, or will have too much capital to lend. Therefore,


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communicating with other teams is crucial to find the balance between the needs andthe abilities of borrowing and lending teams.

the accidental trader user manual

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