Structured Finance Flashcards
What is structured finance?
Structured finance is a financial instrument that involves pooling various financial assets and creating securities backed by those assets.
True or False: Credit risk transfer refers to the shifting of the risk of loss from a borrower to another party.
True
Fill in the blank: A common tool used in structured finance for credit risk transfer is _______.
Collateralized Mortgage Obligations (CMOs)
What does CMO stand for?
Collateralized Mortgage Obligation
Which of the following is a primary benefit of credit risk transfer? (A) Increased liquidity (B) Higher interest rates (C) Reduced transparency
A) Increased liquidity
What type of assets do CMOs typically pool?
Mortgages
True or False: CMOs can be structured into different tranches with varying levels of risk and return.
True
What is a tranche in the context of CMOs?
A tranche is a portion or slice of a pooled asset that has a specific risk and return profile.
Fill in the blank: The _______ tranche typically has the highest risk and potential return in a CMO structure.
equity
What is meant by ‘credit enhancement’ in structured finance?
Credit enhancement refers to methods used to improve the credit profile of a security to reduce the risk of default.
True or False: Investors in CMOs are exposed to the risk of prepayment by borrowers.
True
What is the primary purpose of creating a CMO?
To redistribute the risk and return characteristics of mortgage-backed securities.
Which regulatory body oversees the activities related to structured finance in the United States?
The Securities and Exchange Commission (SEC)
What is a credit default swap?
A credit default swap is a financial derivative that allows an investor to ‘swap’ or transfer the credit risk of a borrower.
Fill in the blank: _______ is a risk associated with structured finance that refers to the possibility that borrowers will default on their loans.
Credit risk
What are the two main types of structured finance products?
Asset-backed securities (ABS) and mortgage-backed securities (MBS)
True or False: Structured finance can help banks manage their capital requirements.
True
What does the term ‘subordination’ refer to in structured finance?
Subordination refers to the order of payment priority in the event of a default.
Fill in the blank: Investors in the _______ tranche are paid first in a CMO structure.
senior
What is the role of a servicer in a CMO?
The servicer manages the collection of payments and administration of the underlying loans.
True or False: CMOs are typically issued by government agencies only.
False
What is the difference between a CMO and a traditional mortgage-backed security?
CMOs are structured into tranches with varying risk profiles, while traditional mortgage-backed securities are typically sold as a single security.
Fill in the blank: The _______ market is where structured finance products are bought and sold.
secondary
What is the importance of cash flow modeling in structured finance?
Cash flow modeling is used to predict the performance of the underlying assets and assess the risk associated with different tranches.
True or False: Structured finance products are only used by large financial institutions.
False
What is the primary risk investors face when investing in structured finance products?
Credit risk and prepayment risk
