#42: ABS

Question 1

An investor in mortgage-backed securities who is concerned about extension risk but willing to accept contraction risk should most appropriately invest in:

Answer 1

Sequential pay CMOs; In a sequential-pay CMO, the early tranches are more exposed to contraction risk, and the later tranches are more exposed to extension risk. PAC securities limit both contraction and extension risk for a range of prepayment rates

Question 2

A covered bond that may postpone the originally scheduled maturity date by as much as a year, to delay default is

Answer 2

soft-bullet covered bond

Question 3

Covered bond converts to a pass-through bond on the maturity date if any payments remain due

Answer 3

conditional pass-through covered bond

Question 4

Covered bond is in default if the issuer fails to make a scheduled payment

Answer 4

hard-bullet covered bond

Question 5

For Commercial MBS, a ____ LTV ratio indicates better credit quality

Answer 5

The lower, the more protection the mortgage lender has in making the loan

Question 6

For Commercial MBS, a ____ debt-service coverage ratio indicates better credit quality

Answer 6

Higher, indicates that the borrower have more income from which to pay interest and principal on their debt

Question 7

Provide prepayment protection for one or more PAC tranches

Answer 7

The purpose of a support tranche

Question 8

A synthetic collateralized debt obligation (CDO) is backed by a pool of:

Answer 8

Credit default swaps

Question 9

In contrast with most asset-backed securities (ABS), a collateralized debt obligation (CDO):

Answer 9

employs a collateral manager; Collateral manager buys and sells within the asset pool to generate cash flows from cap gains or interest

Question 10

A renegotiable or rollover mortgage has an initial fixed-rate period after which the interest rate changes to:

Answer 10

another fixed rate

Question 11

A hybrid mortgage has an initial fixed-rate period after which the interest rate changes to:

Answer 11

variable rate

Question 12

Mortgage may be changed from fixed-rate to variable-rate or from variable-rate to fixed-rate at the borrower’s option

Answer 12

convertible mortgage

Question 13

Which class of asset-backed securities typically includes a lockout period?

Answer 13

Credit card ABS typically have a lockout period during which principal payments by credit card borrowers are used to purchase additional credit card debt, rather than paid out to the ABS holders.

Question 14

All automobile loan ABS have some sort of _____ to make them attractive to institutional investors.

Answer 14

credit enhancement:

Question 15

A senior/subordinated structure in an ABS, in which risk of losses due to defaults on the underlying loans is redistributed among different classes of ABS holders.

Answer 15

credit tranching

Question 16

Redistributes prepayment risk among different classes of ABS holders

Answer 16

Time tranching

Time tranching addresses the uncertainty of a decline in interest rates, because if interest rates drop people are more likely to prepay sooner

Question 17

An annualized measure of the prepayments experienced by a pool of mortgages is its:

Answer 17

conditional prepayment rate (CPR)

Annualized SSM: the amount not being prepaid in a year

Question 18

the percentage by which prepayments have reduced the month-end principal balance

Answer 18

single monthly mortality rate (the amount that is being prepaid) SSM

Question 19

monthly series of CPRs to which a mortgage pool’s CPR may be compared

Answer 19

PSA prepayment benchmark

Question 20

= mortgage rate – fees

Answer 20

Pass-through rate (less than the interest rate on the underlying pool of mortgages because of issuance costs and fees)
the coupon rate of the a mortgage pass-through security
Security holders receive the pass-through rate

Question 21

Asset-backed securities (ABS) may have a higher credit rating than the seller’s corporate bonds because:

Answer 21

they are issued by a SPE; seller’s do not have claim against the pool of assets, bankruptcy remote

Question 22

The process in which a set of bond classes or tranches is created that allow investors a choice in the type of prepayment risk—extension or contraction—that they prefer to bear

Answer 22

Time tranching

Question 23

Allow investors to choose the amount of credit risk that they prefer to bear

Answer 23

Credit tranching: Senior and subordinated bond classes are used

Question 24

Credit tranching is a form of credit enhancement called:

Answer 24

Subordination (Waterfall structure)

Bond classes are created with a waterfall structure, for sharing losses (credit tranching)
Cascading flow of payments between bond classes in the event of default (waterfall structure)

Question 25

Mortgage with no scheduled principal repayments over the entire life of the loan.
At maturity, a balloon payment equal to the original loan amount, is required

Answer 25

Bullet mortgage (interest-only mortgage)

Question 26

In the event of a borrower default on a loan, the lender can look to both the property and the borrower to recover the outstanding mortgage balance.

Answer 26

recourse loan

The bank will sell the home & recover the difference in what’s still owed from the borrower

Question 27

Mortgage rate on the underlying pool of mortgages:

Answer 27

Weighted average coupon (WAC)

Pass through rate: coupon rate of the mortgage pass-through security = Mortgage rate (WAC) - fees

Question 28

have limited (but not complete) protection against both extension risk and contraction risk; This protection is provided by the support tranches

Answer 28

PAC tranches

Question 29

Investors are willing to accept prepayment risk in exchange for higher returns

Answer 29

Use Support tranches

Question 30

This agency RMBS is designed to distribute prepayment risk to various tranches

Answer 30

collateralized mortgage obligations (CMOs)

Question 31

Used to achieve the desired credit rating

Answer 31

subordination

Question 32

Investors in commercial mortgage-backed securities (CMBS) face balloon risk, which is most likely a type of:

Answer 32

extension risk; the risk that the borrower will not be able to arrange for refinancing or sell the property to make the balloon payment typically associated with commercial loans backing CMBS. As a result, the CMBS may extend in maturity, implying that balloon risk is a type of extension risk.

Question 33

For commercial mortgage based securities:
structural call protections:
loan level call protections:

Answer 33

• Tranching
• Prepayment lockout:
• Penalty points: charged against borrowers who repay mortgage principal
• Each point is 1% of the principal amount prepaid
• Defeasance: borrower purchases securities as collateral to cover remaining principal balance plus an amount to substitute for what the yield would have been
• Give the SPE enough money to buy the treasuries that provide the cash flows that take care of the remaining required payments
• Yield maintenance charges: designed to make the borrower indifferent to refinancing at lower rate
• If refinanced, borrower must make yield whole

Question 34

Which type of loan is often used in CMBS?

Answer 34

balloon loans

Question 35

a form of internal credit enhancement that limits credit risk.
It is an amount that can be retained and deposited into a reserve account and that can serve as a first line of protection against losses

Answer 35

An excess spread account, sometimes called excess interest cash flow

Question 36

During the lockout period, the cash flow that is paid out to owners of credit card receivable asset-backed securities is based only on

Answer 36

finance charges collected and fees

Question 37

period during which the principal repaid is reinvested to acquire additional loans with a principal equal to the principal repaid

Answer 37

lock out period for non-amortizing, non-mortgage ABS (autos and CC)

Question 38

In the event of a default by the borrower, the lender can only foreclose the property and recover those assets

Answer 38

Non-recouse loan

The lender is not able to come after the borrower for any of the outstanding loan, after the sale of the property

Question 39

What is the collateral often used in agency mortgage pass-through securities:

Answer 39

Conforming mortgages

Conforming mortgages simply meet all of the underwriting standards and can be included in the pool of assets