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Questions and Answers
Which of the following statements about credit enhancement structures in asset-backed security (ABS) securitizations is most accurate?
Which of the following statements about credit enhancement structures in asset-backed security (ABS) securitizations is most accurate?
- The level of excess spread is independent of the coupon rate in the ABS.
- Overcollateralization is necessary to earn excess spread in the ABS.
- Higher levels of collateral are beneficial for generating excess spread. (correct)
Under a waterfall structure:
Under a waterfall structure:
- principal repayments are first directed to the subordinated tranches.
- senior tranches carry more prepayment risk than junior tranches.
- tranches do not receive a pro rata share of principal and interest payments. (correct)
An asset-backed security with a senior/subordinated structure is said to have:
An asset-backed security with a senior/subordinated structure is said to have:
- time tranching.
- credit tranching. (correct)
- prepayment tranching.
A covered bond that may postpone the originally scheduled maturity date by as much as a year to delay default is:
A covered bond that may postpone the originally scheduled maturity date by as much as a year to delay default is:
Which of the following classes of asset-backed securities typically includes a lockout period?
Which of the following classes of asset-backed securities typically includes a lockout period?
If the market reference rate (MRR) is 3%, determine whether credit risk is fully mitigated by this structure.
If the market reference rate (MRR) is 3%, determine whether credit risk is fully mitigated by this structure.
A company originating an asset-backed security (ABS) has built up significant reserves within the ABS structure in order to absorb credit losses in collateral. This credit enhancement type is best described as:
A company originating an asset-backed security (ABS) has built up significant reserves within the ABS structure in order to absorb credit losses in collateral. This credit enhancement type is best described as:
A covered bond that is in default if the issuer fails to make a scheduled payment is:
A covered bond that is in default if the issuer fails to make a scheduled payment is:
In contrast with most asset-backed securities (ABS), a collateralized debt obligation (CDO):
In contrast with most asset-backed securities (ABS), a collateralized debt obligation (CDO):
Based on the table below illustrating an asset-backed security (ABS) structure, what is the value of the equity tranche (in $ millions)?
Based on the table below illustrating an asset-backed security (ABS) structure, what is the value of the equity tranche (in $ millions)?
Compared to otherwise equivalent asset-backed securities, covered bonds offer:
Compared to otherwise equivalent asset-backed securities, covered bonds offer:
A synthetic collateralized debt obligation (CDO) is backed by a pool of:
A synthetic collateralized debt obligation (CDO) is backed by a pool of:
A collateralized debt obligation (CDO) in which the collateral is a pool of residential mortgage-backed securities is most accurately described as a:
A collateralized debt obligation (CDO) in which the collateral is a pool of residential mortgage-backed securities is most accurately described as a:
With respect to auto-loan backed ABS:
With respect to auto-loan backed ABS:
Flashcards
Credit Enhancement Structures
Credit Enhancement Structures
Structures within ABS securitizations used to reduce credit risk.
Waterfall Structure
Waterfall Structure
An ABS structure that directs payments sequentially based on seniority.
Credit Tranching
Credit Tranching
An ABS structure where risk is redistributed among different tranches.
Soft-bullet Covered Bond
Soft-bullet Covered Bond
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Lockout Period
Lockout Period
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Excess Spread
Excess Spread
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Excess spread
Excess spread
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Hard-Bullet Covered Bond
Hard-Bullet Covered Bond
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Collateral Manager
Collateral Manager
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Equity Tranche
Equity Tranche
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Covered Bonds
Covered Bonds
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Synthetic CDO
Synthetic CDO
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Structured Finance CDO
Structured Finance CDO
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Credit Enhancement
Credit Enhancement
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Study Notes
Credit Enhancement in ABS Securitizations
- Higher collateral levels increase income, boosting excess spread relative to ABS coupons.
- Excess spread relies primarily on interest rates, depending on collateral income and coupon interest.
- Overcollateralization isn't essential for excess spread.
Waterfall Structure in ABS
- All tranches are paid interest.
- Senior tranches are first to receive principal repayments.
- Senior tranches have less prepayment risk relative to junior tranches.
- Payments aren't made pro rata across all tranches.
Senior/Subordinated Structure
- Senior/subordinated structure establishes credit tranching in an ABS.
- Credit tranching is when risk of losses from underlying loan defaults is reallocated among ABS holder classes.
- Time tranching redistributes prepayment risk among different classes of ABS holders.
Soft-Bullet Covered Bonds
- Soft-bullet covered bonds may postpone scheduled maturity date by up to one year.
- Hard-bullet covered bonds default if the issuer doesn't make scheduled payments.
- Conditional pass-through bonds convert to pass-through bonds on maturity if payments are due.
Lockout Period in ABS
- Credit card ABS use a lockout period.
- Principal payments from credit card borrowers are used to buy more credit card debt during lockout, instead of paying ABS holders.
ABS Credit Risk Mitigation
- When the market reference rate (MRR) is 3%:
- Tranche A senior notes: $120, MRR + 0.25%, Interest: ($3.90)
- Tranche B subordinated notes: $20, MRR + 1.25%, Interest: ($0.85)
- Tranche C equity tranche: $10
- Collateral: $150, MRR + 0.75%, Interest: $5.63
- Excess spread totals $0.88
- A positive excess spread offers a safety net, protecting the ABS from credit losses.
Excess Spread in ABS
- Excess spread is used in ABS to absorb credit losses in the collateral.
- Overcollateralization occurs when the collateral value exceeds the ABS value.
- Credit tranching absorbs credit losses through different priority classes of securities.
Hard-Bullet Covered Bonds
- A hard-bullet covered bond goes into default if scheduled payments aren't made.
- A soft-bullet bond can postpone the maturity date by up to a year from the original date.
- A conditional pass-through covered bond changes into a pass-through on the maturity date if there are payments remaining.
Collateralized Debt Obligation (CDO)
- CDOs differ as they employ a collateral manager to manage the collateral.
- The collateral manager buys/sells securities in the collateral pool for cash to meet the CDO's obligations.
Equity Tranche in ABS
- The equity tranche is the most subordinated/least senior tranche.
- The equity tranche face value absorbs first $10 million in losses.
Covered Bonds vs. ABS
- Covered bonds give bondholders recourse to the issuing firm, but ABS do not.
- Covered bonds have a higher credit quality and lower yields relative to comparable ABS due to recourse.
Synthetic CDOs
- Synthetic CDOs are backed by credit default swaps.
- CLOs are backed by leveraged bank loans.
- CDOs backed by other CDOs are structured finance CDOs.
Structured Finance CDOs
- Structured finance CDOs have mortgage-backed securities, asset-backed securities, or other CDOs as collateral.
- Synthetic CDOs use credit default swaps as collateral.
- CLOs use leveraged bank loans as collateral.
Credit Enhancement in Auto-Loan Backed ABS
- Every auto loan ABS has some type of credit enhancement.
- Credit enhancement makes them attractive to institutional investors.
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