Structured Finance

Question 1

What is structured finance?

Answer 1

Structured finance is a financial instrument that involves pooling various financial assets and creating securities backed by those assets.

Question 2

True or False: Credit risk transfer refers to the shifting of the risk of loss from a borrower to another party.

Answer 2

True

Question 3

Fill in the blank: A common tool used in structured finance for credit risk transfer is _______.

Answer 3

Collateralized Mortgage Obligations (CMOs)

Question 4

What does CMO stand for?

Answer 4

Collateralized Mortgage Obligation

Question 5

Which of the following is a primary benefit of credit risk transfer? (A) Increased liquidity (B) Higher interest rates (C) Reduced transparency

Answer 5

A) Increased liquidity

Question 6

What type of assets do CMOs typically pool?

Answer 6

Mortgages

Question 7

True or False: CMOs can be structured into different tranches with varying levels of risk and return.

Answer 7

True

Question 8

What is a tranche in the context of CMOs?

Answer 8

A tranche is a portion or slice of a pooled asset that has a specific risk and return profile.

Question 9

Fill in the blank: The _______ tranche typically has the highest risk and potential return in a CMO structure.

Answer 9

equity

Question 10

What is meant by ‘credit enhancement’ in structured finance?

Answer 10

Credit enhancement refers to methods used to improve the credit profile of a security to reduce the risk of default.

Question 11

True or False: Investors in CMOs are exposed to the risk of prepayment by borrowers.

Answer 11

True

Question 12

What is the primary purpose of creating a CMO?

Answer 12

To redistribute the risk and return characteristics of mortgage-backed securities.

Question 13

Which regulatory body oversees the activities related to structured finance in the United States?

Answer 13

The Securities and Exchange Commission (SEC)

Question 14

What is a credit default swap?

Answer 14

A credit default swap is a financial derivative that allows an investor to ‘swap’ or transfer the credit risk of a borrower.

Question 15

Fill in the blank: _______ is a risk associated with structured finance that refers to the possibility that borrowers will default on their loans.

Answer 15

Credit risk

Question 16

What are the two main types of structured finance products?

Answer 16

Asset-backed securities (ABS) and mortgage-backed securities (MBS)

Question 17

True or False: Structured finance can help banks manage their capital requirements.

Answer 17

True

Question 18

What does the term ‘subordination’ refer to in structured finance?

Answer 18

Subordination refers to the order of payment priority in the event of a default.

Question 19

Fill in the blank: Investors in the _______ tranche are paid first in a CMO structure.

Answer 19

senior

Question 20

What is the role of a servicer in a CMO?

Answer 20

The servicer manages the collection of payments and administration of the underlying loans.

Question 21

True or False: CMOs are typically issued by government agencies only.

Answer 21

False

Question 22

What is the difference between a CMO and a traditional mortgage-backed security?

Answer 22

CMOs are structured into tranches with varying risk profiles, while traditional mortgage-backed securities are typically sold as a single security.

Question 23

Fill in the blank: The _______ market is where structured finance products are bought and sold.

Answer 23

secondary

Question 24

What is the importance of cash flow modeling in structured finance?

Answer 24

Cash flow modeling is used to predict the performance of the underlying assets and assess the risk associated with different tranches.

Question 25

True or False: Structured finance products are only used by large financial institutions.

Answer 25

False

Question 26

What is the primary risk investors face when investing in structured finance products?

Answer 26

Credit risk and prepayment risk