L9

Question 1

explain how an asset becomes securitised: generaliszed

Answer 1

process of taking an illiquid asset or group of assets and through financial engineering, transforming it into a security
cf and econmic values of these loans and other fiancail assets are redirected to support payment of ABS

Question 2

Advantages of ABS

Answer 2

new source of funding
reduce borrowing cost
reduce minimum capital constrain for banks
assets of b/s
risk is more accurately priced
provides liquidity to assets classes that are typically less liquid by converting them to tradeable securities

Question 3

Disadvan of ABS

Answer 3

encourage loan issuers to issue more loans and reduce quality of screen and monitoring
complexity and less transparency
encourage more risk taking
reduce standard of lending

Question 4

how banks securitise assets

Answer 4

created by removing assets from b/s (replaced by cash received from buyer) (increases capital to asset ratio (Basel II)
sells pledged assets to special purpose vehicle (not owned by bank)
svp issue debt to public market, using pledged asset to securitise it
-yield based on quality of pledged assets- higher raitng= lower yield

Question 5

steps how to securtiuze

Answer 5

1. remove from b/s, replace with cash from new buyer
   2.bank grants loans to borrowers
2. borrowers make regular payments to banks
3. bank passes pool of loans onto spv
   5.svp issues debt securities
4. inermeidatry between issued and investor receive fee to facilated placement of abs
5. buy of abs are banks, insurance comp and pension funds
6. buyers make payments to svp for abs
7. buyers recieve interest rate payments (dividends)
8. credit enchances increase likelihood that buyers of abs recieve timely payments on their investment
9. banks pay insurance fees to credit enchancers

Question 6

sub-prime crisis start

Answer 6

started in US after sept 11, fed cut interrst rates as low as 1% in 2004 jun
cheap credit boosted rate of econ activity
property market, benefited with sharp rise in house prices
credit extended to lwoer-income (non-prime) borrowers
boom happened, but crashed with tighter monetary policy and increase interest rates on lonas and mortgages
housing market crashed

Question 7

degrees of mortgages

Answer 7

prime: borrowers with good credit history and fully documented income
subpime: applicants deemd to be the least credit worthy
near-prime: better than sub-prime but not able to fully document income

sub prime and near prime shot up from 9% to 40% of securitzed mortgages from 01-06

Question 8

bank point of view

Answer 8

issue associated with providing sub-prime loan
-risker pop
-insufficient funds for down payments
-credit issues
undocumented income
-lack of correct info

hard to lend to this pop
banks used securitization to lend them money

Question 9

packaging of the non prime mortgages

Answer 9

called cdo (collateralized debt obligation
mainly purchased by international banks
not sure who had greatest exposure to the risk
soon speculation move in and banks were exposed
-investor liquidate their holding in bs
banks suspicous and reluctant to lend each other
-fed, boe force to inject liquidty to ensure banks were able to contineue lending to one another

Question 10

CDO

Answer 10

diverisifed pool of diff types of debt obligations
senior investors were easy to find
creation of abs of abs= cdos
start very low default rates 02-05=6%
bubble burst
house price begain to slowly fall 06-07
default went up to 40%

Question 11

what went wrong

Answer 11

excessive optimism, ending, use of securitization by banks and belief in cra