Reading 45: introduction to asset backed securities Flashcards
Economic benefits of securitization least likely include:
reducing excessive lending by banks.
reducing funding costs for firms that securitize assets.
increasing the liquidity of the underlying financial assets.
Banks that securitize loans they hold as assets receive cash with which they can make additional loans. The primary benefits of securitization to the economy include reducing firms’ funding costs and increasing the liquidity of the financial assets that are securitized. (LOS 45.a)
In a securitization, the issuer of asset-backed securities is best described as:
the SPE.
the seller.
the servicer.
ABS are issued by a special purpose entity (SPE), which is an entity created for that specific purpose. In a securitization, the firm that is securitizing financial assets is described as the seller because it sells the assets to the SPE. The servicer is the entity that deals with collections on the securitized assets. (LOS 45.b)
A mortgage-backed security with a senior/subordinated structure is said to feature:
time tranching.
credit tranching.
a pass-through structure.
Senior and subordinated tranches are characteristics of a mortgage-backed security with credit tranching. (LOS 45.c)
A mortgage that has a balloon payment equal to the original loan principal is:
a convertible mortgage.
a fully amortizing mortgage.
an interest-only lifetime mortgage.
An interest-only lifetime mortgage includes no repayment of principal in its monthly payments so the balloon payment at maturity is equal to the original loan principal. A fully amortizing mortgage has no balloon payment at maturity. A convertible mortgage gives the borrower an option to change the loan from fixed-rate to adjustable-rate or from adjustable-rate to fixed-rate. (LOS 45.d)
Residential mortgages that may be included in agency RMBS are least likely required to have:
a minimum loan-to-value ratio.
insurance on the mortgaged property.
a minimum percentage down payment.
Conforming loans that may be securitized in agency RMBS have a maximum loan-to-value ratio, along with other requirements such as minimum percentage down payments and insurance on the mortgaged property. (LOS 45.e)
The primary motivation for issuing collateralized mortgage obligations (CMOs) is to reduce:
extension risk.
funding costs.
contraction risk.
Issuing CMOs may allow the issuer to raise funds at a lower cost by creating tranches that appeal to investors with different preferences for extension risk and contraction risk. CMOs do not reduce these risks compared to their pool of collateral; they only distribute the risks among the various CMO tranches. (LOS 45.e)
The risk that mortgage prepayments will occur more slowly than expected is best characterized as:
default risk.
extension risk.
contraction risk.
Extension risk is the risk that prepayments will be slower than expected. Contraction risk is the risk that prepayments will be faster than expected. (LOS 45.e, 45.f)
For investors in commercial mortgage-backed securities, balloon risk in commercial mortgages results in:
call risk.
extension risk.
contraction risk.
Balloon risk is the possibility that a commercial mortgage borrower will not be able to refinance the principal that is due at the maturity date of the mortgage. This results in a default that is typically resolved by extending the term of the loan during a workout period. Thus, balloon risk is a source of extension risk for CMBS investors. (LOS 45.g)
During the lockout period of a credit card ABS:
no new receivables are added to the pool.
investors do not receive interest payments.
investors do not receive principal payments.
During the lockout period on a credit card receivables-backed ABS, no principal payments are made to investors. (LOS 45.h)
A debt security that is collateralized by a pool of the sovereign debt of several developing countries is most likely:
a CMBS.
a CDO.
a CMO.
A collateralized debt obligation (CDO) is backed by an underlying pool of debt securities, which may include emerging markets debt. Both collateralized mortgage obligations and commercial mortgage-backed securities are backed by mortgages only. (LOS 45.i)
A covered bond is most likely to feature:
a fixed cover pool.
recourse to the issuer.
a special purpose entity.
Covered bonds differ from ABS in that bondholders have recourse to the issuer as well as the cover pool. Covered bonds are not issued through special purpose entities. A covered bond issuer must maintain a dynamic cover pool, replacing any nonperforming or prepaid assets. (LOS 45.j)
