Chapter 25 CAÍA Flashcards - Introduction to Structuring

1
Q

Complete Market

A

A complete market is a financial market in which enough different types of distinct securities exist to meet the needs and preferences of all participants.

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2
Q

Tranche

A

A tranche is a distinct claim on assets that differs substantially from other claims in such aspects as seniority, risk, and maturity. Each tranche is typically tradable in units that may differ in size.

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3
Q

Sequential Pay Collateralized Mortgage Obligation

A

The sequential-pay collateralized mortgage obligation is the simplest form of CMO. In a sequential-pay CMO, each tranche receives a prespecified share of the interest payments based on each tranche’s coupon and principal amount. Each tranche also potentially receives principal. When there is no default risk, it is the seniority to principal payments that is the focus of CMOs.

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4
Q

PLANNED AMORTIZATION CLASS TRANCHES

A

PLANNED AMORTIZATION CLASS TRANCHES: Planned amortization class (PAC) tranches receive principal payments in a more complex manner than do sequential-pay CMOs. Investors in some PAC tranches have high priority for receiving principal payments as long as the prepayment rates are within a prespecified range (the planned prepayment levels). When prepayments diverge from what was originally projected, the relative priorities of tranches can shift. In a sequential-pay structure, the relationship between tranche longevity and prepayment rates is somewhat linear, meaning that each tranche’s longevity to changes in prepayment speeds is somewhat stable at various levels of prepayment.

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5
Q

TARGETED AMORTIZATION CLASS TRANCHES:

A

TARGETED AMORTIZATION CLASS TRANCHES: Targeted amortization class (TAC) tranches receive principal payments in a manner similar to PAC tranches but generally with an even narrower and more complex set of ranges. The amortization procedures tend to identify narrower ranges of prepayment speeds within which tranches have particular priorities for receiving principal payments and interest. These prepayment ranges can be viewed more as targeted outcomes than as planned outcomes. TAC tranches can be especially complex and risky. A sensitive TAC tranche can quickly switch from being quickly paid off to receiving no principal payments (and vice versa), even when prepayment speeds change by only a small amount.

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6
Q

PRINCIPAL-ONLY TRANCHES AND INTEREST-ONLY TRANCHES:

A

Principal-only (PO) tranches receive only principal payments from the collateral pool, whereas interest-only (IO) tranches receive only interest payments from the collateral pool. Both tranches are therefore created by dividing cash flows from the mortgage collateral ​into the portion that is principal repayment and the portion that is interest. The principal repayment cash flows are distributed to one bond, the PO, and the interest cash flows are distributed to a second bond, the IO.

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7
Q

FLOATING-RATE TRANCHES:

A

FLOATING-RATE TRANCHES: Floating-rate tranches earn interest rates that are linked to an interest rate index, such as the London Interbank Offered Rate (LIBOR), and are usually used to finance collateral pools of adjustable-rate mortgages.

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8
Q

An inverse floater tranche

A

An inverse floater tranche offers a coupon that increases when interest rates fall and decreases when interest rates rise. Floating-rate tranches can have specified upper and lower limits to their adjustable coupons.

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9
Q

Call Option View of Capital Structure

A

The call option view of capital structure views the equity of a levered firm as a call option on the assets of the firm.

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10
Q

Put Option View of Capital Structure

A

The put option view of capital structure views the equity holders of a levered firm as owning the firm’s assets through riskless financing and having a put option to deliver those assets to the debt holders.

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11
Q

CDO

A

A collateralized debt obligation (CDO) applies the concept of structuring to cash flows from a portfolio of debt securities into multiple claims; these claims are securities and are referred to as tranches.

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