Module 45.1: Structure of Mortgage Backed Securities

Question 1

What are the two primary benefits of securitization?

Answer 1

1) a reduction in funding costs for firms selling the financial assets to the securitizing entity
2) an increase in the liquidity of the underlying financial assets

Question 2

What is credit tranching?

Answer 2

ABS tranches will have different exposures to the risk of default of the assets underlying the ABS.

Subordinated tranches absorb credit losses as the occur (up to their principal values). Level of protection on the senior tranches increases with the size of the subordinated tranche.

Question 3

What are sub prime or prime residential mortgage lo ans?

Answer 3

sub prime - lower credit quality, and lower priority claim in the event of default

prime - mortgages with higher LTV ratios made to borrowers with good credit