Midterm Part C

Question 1

What are Asset-Backed Securities (ABS) and Special purpose vehicle (SPV)?

Answer 1

Asset-Backed Securities (ABS): are securities backed by a pool of loans or receivables (e.g., accounts receivables, auto loans and leases, credit cards, student loans etc.)

Special purpose vehicle (SPV): is a separate legal entity to which a corporation transfers the assets for an ABS issue

Question 2

Define Mortgage passthrough securities?

Answer 2

Mortgage passthrough securities: Created when mortgage holders form a collection (or “pool”) of mortgages and sell shares or participation certificates in the pool

Question 3

what is the weak link approach?

Answer 3

The weak link approach

• means that the credit rating of a credit-enhanced bond is determined by the weaker financial strength between the bond issuer and the credit enhancer (or guarantor).
• Even if one party is strong, the overall rating is limited by the weaker party because the bond’s safety depends on both.

Question 4

What are the The four C’s of credit: factors affecting credit rating?

Answer 4

Character: the quality of management
Capacity: an issuer’s ability to pay
Collateral: the quality and value of both pledged and unpledged assets
Covenants: affirmative covenants and negative covenants

Question 5

define Price compression

Answer 5

Price compression: the price appreciation potential of a callable bond is lower than an otherwise identical option-free bond

Question 6

Define Yield to Put and Yield to Call?

Answer 6

Yield to put: For a putable bond, we calculate the yield to put over the period until the bond may (first) be put, and use the put price

Yield to call: For a callable bond, we compute both a yield to maturity (YTM) and a yield to call (YTC)

• The yield to call assumes that the bond issuer will call a bond on some call date at some call price as specified in the call schedule
  • for a callable bond we compute the yield to first call and/or yield to first par call