The customer relationship cycle refers to the series of stages that a buyer takes while considering, purchasing, using, and remaining loyal to a service or product. Reaching, acquisition, conversion, conversion, retention, and commitment are the five stages of the customer relationship cycle. This is responsible for attracting potential consumers' attention, showing them what you have to offer, convincing them to buy, and keeping them as loyal customers whose happiness with the service or product drives additional clients to join the cycle (Baran and Galka 2017).
Adverse selection occurs when buyers have more information than sellers, and it can disrupt the normal market process. It can lead to missing markets as a financial institution does not find it profitable to give out loans.
Question 3
Merton model is an analysis use is used to a credit risk of the organization debt. The investors and the analysts at the brokerage firms use the Merton model to understand the capability of the company in meeting the financial obligation, weighing the possibility that the business will go into credit default servicing its debt.
The underlying assumptions in the Merton model are: market movements are unpredictable; all options are exercised only at the expiration time; returns on the underlying stocks are uniformly distributed; the underlying volatility of stock and risk-free rate are fixed; no commissions. The key variables of the model are the amount of time before expiration, strike price, risk-free rates and option strike price. It enables the investor to know the prices of the underlying asset.
Question 4
Merton’s model gives a complicated relationship between credit spread and the implied volatilities. Some of the financial institutions have opted for linear log regression or simpler linear models of credit spreads against various variables and the implied volatilities.
Although the default are a less frequent, losses can be significant even with the credit portfolios having a considerable number of contracts. As a result, not only the severity of the loose needs to be estimated, but also a proper evaluation of default is essential (Adam 2007, 123). The modelling of recovery rate is carried out independently concerning default probability, while on the other hand, the Merton model results in the functional dependence of the variables. Investigation of the relationship between probability and recovery rate for the senior secured bond is done by the use of Recovery Model and Mody’s Default.
Merton model assumption does not appear justified by the empirical situation. The empirical dependence of recovery rates and the probability is well defined by the functional reliance present in the Merton model.
Question 5
Instrument
operation
Credit risk exposure
Credit default swap
The client buys a contract and makes frequent payments to the vendor of the credit protection
Low risk exposure
Total return swap
One side makes floating or fixed payments while the other one make payment depending on the asset returns
High risk exposure
Credit link note
Investors get high payments for taking risks related to a certain activity
High risk exposure
Question 6
The solutions to the regulatory issues which can affect mitigation and hedging activities in the financial sector are currently being developed. A workable solution has been prepared to solve the conflict which has been built between accounting and regulatory requirements since the financial institutions with many activities can be heavily impacted by the formidable issues. As a result, the solution boosts the competitiveness of the financial institutions in the in the context of derivatives pricing, risk management and help the banks carry out derivative business which will stimulate the economy. Furthermore, potential solution concerns development of credit risk mitigating instruments which reduces CVA risk charge without resulting in profit and loss volatility.
References
Adam, A. (2007). Handbook of asset and liability management: From models to optimal return strategies. Chichester, England: John Wiley & Sons.
Baran, R. J., & Galka, R. J. (2017). Customer relationship management: The foundation of contemporary marketing strategy.
