Boerse Stuttgart and the European Derivatives Group (EDG) have together developed a new risk assessment instrument for bonds issued by medium-sized companies. For the first time, investors now have a tool giving them continuous access to comprehensible risk assessments for all bonds listed in the Bondm segment. The results are represented on a scale of one to five to make them easier to interpret. This means that, in addition to the yearly company ratings, Boerse Stuttgart is now providing investors with access to additional information on individual bonds, updated weekly on www.boerse-stuttgart.de.
The new risk classification instrument is the latest innovation by Boerse Stuttgart in the area of bonds issued by medium-sized companies, following the introduction of the Bondm index. Sabine Traub, Head of Primary Market Group at Boerse Stuttgart, commented: “The new key risk indicators create additional transparency in the Bondm trading segment. The instrument enables investors to assess the dynamic changes in the risk level of a bond at regular intervals. At present there is no comparable risk measure for bonds issued by medium-sized enterprises on the market.”
The risk classes range from conservative (1) to speculative (5) and are derived from the calculated total risk of a bond. The total risk has three components: interest risk, spread risk and default risk. The calculation starts with the current market conditions and changes in the market, especially the current returns on the relevant bond, as well as the market interest rate. The overall concept is based on the Value at Risk (VaR) approach: this predicts with a given probability the maximum loss that can be expected, i.e. the amount of loss that will not be exceeded, over a given period of time. In addition, it identifies the percentage probability of a default within one year.
Philipp Henrich, Management Board Member at EDG AG, remarked: "In the certificates market, the calculation model developed by EDG with German Derivatives Association (DDV) has been the market standard for several years. So investors are already familiar with it. The risk classification helps investors to interpret a current bond return of, for instance, 9 percent, against the background of the associated monetary risks and default probabilities."
Since Boerse Stuttgart launched the Bondm segment for medium-sized enterprises in May 2010, it has listed 20 corporate bonds with a total volume of more than EUR 1.4 billion. Further information on the Bondm trading segment and an overview of the corporate bonds traded there can be found at:
www.boerse-stuttgart.de/en/tradingsegmentsandtradinginitiatives/bondm/bondm.html.
Notes on the Value at Risk approach:
The risk associated with bonds issued by medium-sized enterprises that are listed in Boerse Stuttgart’s Bondm segment is classified on the basis of the adjusted Value at Risk (VaR), with an assumed holding period of 10 days, a confidence level of 99 percent and an investment amount of EUR 10,000. The VaR measures with a probability of 99 percent the loss which will not be exceeded during the holding period. Since the probability of a bond defaulting during the 10-day holding period is normally less than 1 percent, the default risk is not adequately reflected by the unadjusted VaR. For this reason, the risk of Bondm bonds is determined on the basis of an expected value of between 97.5 percent and 100 percent of the profit/loss spread, in order to make adequate allowance for the rare but high losses from a default on the bond. Investors must bear in mind that the total risk is not calculated by simply adding the individual risks, since there is a diversification effect caused by the interdependence of the individual risks.