Question 1

When a vulture fund acquires a distressed loan, the fund usually assists the distressed firm's managers in formulating a long-term plan for restoring profitability.

Accepted Answer

Vulture funds typically acquire distressed loans with the intention of maximizing their own profits, rather than assisting the distressed firm's managers in formulating a long-term plan for restoring profitability.

Question 2

Loans sold to correspondent banks are predominantly sales of distressed HLT loans.

Accepted Answer

The statement is not completely accurate. Loans sold to correspondent banks can include both performing and non-performing loans, not just distressed HLT loans.

Question 3

A CMO is a multiclass pass-through that helps investors choose the amount of prepayment risk they will face.

Accepted Answer

A CMO (Collateralized Mortgage Obligation) does indeed help investors choose the amount of prepayment risk they will face. It does this by dividing mortgage pools into different tranches, each with different predetermined levels of prepayment risk. Investors can then choose which tranche to invest in based on their risk tolerance.

Question 4

A loan sold without recourse generates a contingent liability for the selling bank.

Accepted Answer

A loan sold without recourse means that the buyer assumes all the risk and responsibility for the loan, so the selling bank does not have a contingent liability.

Question 5

In 2008, loan sales primarily consisted of sales of distressed loans.

Accepted Answer

In 2008, loan sales included a mix of both distressed loans due to the financial crisis and regular, performing loans as part of normal banking operations. The perception of loan sales being primarily distressed is influenced by the financial crisis, but not all loan sales were of distressed loans.

Question 6

Because of the government backing, investors in GNMA pass-throughs are guaranteed to earn at least the T-bill rate on their investments.

Accepted Answer

While GNMA pass-throughs are government-backed, investors are not guaranteed to earn at least the T-bill rate on their investments as the value of their investment can fluctuate based on changes in interest rates and prepayment speeds.

Question 7

Most loan sales are now accomplished in about 10 days.

Accepted Answer

With the use of technology and streamlined processes, most loan sales are now completed within 10 days.

Question 8

An investor in a GNMA mortgage-backed security may be able to earn a return higher than the rate on a comparable maturity Treasury without taking on much, if any, default risk.

Accepted Answer

GNMA mortgage-backed securities are issued by the government and backed by pools of mortgages insured by the FHA, which reduces default risk. As a result, investors can potentially earn a higher return than a Treasury security of similar maturity without taking on additional default risk.

Question 9

A pass-through security is best characterized as

Accepted Answer

A pass-through security is a type of mortgage-backed security where investors receive cash flows based on the underlying pool of mortgages. The cash flows are "passed through" to the investors on a pro rata basis, depending on their ownership in the security. The underlying mortgages are held in a trust, and the payments made by the homeowners (principal and interest) are distributed to the investors.

Question 10

The sale or transfer of assets at less than fair value that occurs at a time when the seller is insolvent is termed fraudulent conveyance.

Accepted Answer

According to the law, a sale or transfer of assets at less than fair value that occurs while the seller is insolvent constitutes a fraudulent conveyance.

Question 11

In selling loans, FIs act as an asset _____ and in creating CMOs, FIs act as an asset _____.

Accepted Answer

In selling loans, Financial Institutions (FIs) act as an asset broker, facilitating the sale of loans to other parties. In creating Collateralized Mortgage Obligations (CMOs), FIs act as an asset transformer, repackaging mortgages into securities that can be sold to investors.

Question 12

More than 90% of loan sales are via assignments.

Accepted Answer

According to industry experts, more than 90% of loan sales are conducted through assignments, which involve the transfer of ownership and rights to collect payments on the loan.

Question 13

Advantages of Brady bonds over LDC loans include improved liquidity and higher coupon rates.

Accepted Answer

Brady bonds were created to restructure the debt of developing countries and improve liquidity, but they do not inherently offer higher coupon rates compared to less developed country (LDC) loans. The main advantage is the enhancement of liquidity and potentially better terms for the debtor countries, not necessarily higher interest rates for the investors.

Question 14

Which one of the following types of transactions leaves the assets on the balance sheet?

Accepted Answer

Mortgage-backed bonds issued keep the assets on the balance sheet because the issuer retains ownership of the underlying mortgages.

Question 15

Advantages of loan sales and securitization typically include all but which one of the following?

Accepted Answer

The answer of Advantages of loan sales and securitization typically...

Question 16

An advantage of securitization and loan sales over interest rate swaps as a risk-management tool is that securitization, by removing loans from the balance sheet, reduces the regulatory tax imposed by existing regulations.

Accepted Answer

Securitization can reduce the regulatory tax imposed by existing regulations by removing loans from the balance sheet, while interest rate swaps do not have this effect.

Question 17

Under current reserve requirements, bank loan sales with recourse are considered a liability and are subject to reserve requirements.

Accepted Answer

Bank loan sales with recourse are considered a liability and are subject to reserve requirements as per current regulations.

Question 18

A mortgage pass-through security is a bond issue backed by a group of mortgages that pays fixed semi-annual coupon payments where the principle is repaid only at maturity.

Accepted Answer

A mortgage pass-through security pays monthly payments that include both interest and principal, as the underlying mortgages are paid down, rather than fixed semi-annual coupon payments with principal repaid only at maturity.

Question 19

The buyer of a loan in a participation has a double-risk exposure: one to the borrower and one to the selling bank.

Accepted Answer

In a loan participation, the buyer assumes a portion of the risk associated with the loan. This includes the risk of the borrower defaulting on the loan, as well as the risk of the selling bank defaulting or failing to perform its obligations under the participation agreement. Therefore, the buyer has a double-risk exposure.

Question 20

Vulture funds specialize in buying distressed loans.

Accepted Answer

Vulture funds typically seek out distressed loans or assets that have declined in value and are in financial trouble, with the aim of buying them at a discount and ultimately profiting from their recovery or sale.

Quiz 24: Managing Risk Off the Balance Sheet With Loan Sales and Securitization