Deck 11: Securitization

Question 1

An asset-backed bond is usually overcollateralized because

A)overcollateralization serves to reduce risk to investors and therefore reduces the required yield for the asset.
B)overcollateralization mitigates moral hazard.
C)overcollateralization improves risk sharing in the sense that investors are protected against decreases in the value of collateral between valuation dates.
D)all of the above
E)only b and c

Answer 1

D

Question 2

The main reason for decomposing a bank's traditional lending functions is

A)volatile interest rates
B)changes in information technology
C)changes in regulatory environment
D)competition
E)b and c only

Answer 2

E

Question 3

Which of the following functions best describe the traditional lending functions?

A)origination, servicing, and funding
B)origination, funding, and selling off the loans to third parties
C)origination, guaranteeing, servicing, and funding
D)origination, guaranteeing, and funding
E)origination and funding

Answer 3

C

Question 4

Stripped securities offer the following advantages):

A)they reduce informational asymmetry by partitioning the securities' cash flows based on the degree of information sensitivity.
B)they help to better manage interest rate risk.
C)they help to better manage default risk.
D)only b and c
E)only a and b

Question 5

The main difference between an asset-backed bond and a pass-through is

A)an asset-backed bond is collateralized by a portfolio of loans while a pass- through is not.
B)an asset-backed bond remains on the originator's consolidated balance sheet while a pass-through does not.
C)an asset-backed bond is sold directly to investors by the originator while a pass- through is sold through a trust.
D)an asset-backed bond is unsecured while a pass-through is secured.
E)All of the above

Question 6

Relative to a standard deposit contract, securitization with recourse can improve risk sharing because

A)the bank can partition the riskiness of the claims and therefore can sell the claims to investors with different risk preferences.
B)securitization with recourse is also backed by the FDIC.
C)securitization with recourse offers the investors an opportunity to obtain a riskless asset.
D)securitization with recourse allows the bank to generate higher profit.
E)none of the above

Question 7

Which of the following statements is true?

A)Similar to a pass-through, a pay-through does not appear on the originator's balance sheet.
B)The cash flows from the pool of assets used as collateral in a pay-through are not dedicated to servicing the bond.
C)Similar to an asset-backed bond, a pay-through remains on the originator's balance sheet.
D)A pay-through is secured while a pass-through is not.
E)All of the above

Question 8

The benefits to securitization from the issuer's perspective are that

A)it helps to reduce the degree of private information contained in an illiquid asset and therefore liquefies the issuer's financial conditions.
B)it permits the issuer to avoid reserve and capital requirements.
C)it reduces market incompleteness.
D)a and b only
E)a and c only

Question 9

Which of the following assets is easier to securitize?

A)An asset with a large bid-ask spread.
B)An opaque asset.
C)An information-sensitive asset.
D)An information-insensitive asset.
E)A pool of mortgage loans without credit enhancement.

Question 10

A pass-through is

A)an indirect ownership in a portfolio of mortgage loans with similar interest rate.
B)an indirect ownership in a portfolio of mortgage loans with similar maturity.
C)a direct ownership in a portfolio of mortgage loans which share similar maturity, interest rate and quality characteristics.
D)a direct ownership in a portfolio of mortgage loans backed by government.
E)a direct ownership in a portfolio of commercial loans originated by well- capitalized financial intermediaries.

Question 11

Which of the following characteristics describes a static pool pass-through?

A)the loans are held in a trust.
B)monthly interest and principal payments are normally provided.
C)it is tax-exempt at the beneficiary level.
D)a and b only
E)all of the above

Question 12

Which of the following statements best describes the characteristics of a Collateralized Mortgage Obligation CMO)?

A)Each issue is divided into several tranches that are strictly prioritized in terms of the receipts of the scheduled principal and interest repayments.
B)The CMO holders have a call protection in the sense that the bonds will not be prematurely called.
C)Because the CMO is divided into several tranches, the holder of each tranche no longer bears any risk.
D)Only a and b
E)Only b and c

Question 13

Under what conditions must the seller keep capital against the securitized asset?

A)An asset is sold along with a put option that entitles the buyer to sell the asset
Back to the seller.
B)The sale of an asset is guaranteed by a third party with a portion of the risk
Remaining with the seller.
C)The sale of a short-term commitment.
D)All of the above
E)None of the above

Question 14

Which of the following statements describes the reasons for the proliferation of new types of securitization contracts?

A)The decline in interest rates gives rise to prepayment risk and the securitization contracts help investors manage the prepayment risk better.
B)The securitization contracts offer uninformed investors an instrument to reduce their handicap due to information asymmetry.
C)The securitization contracts offer the issuer higher revenues.
D)All of the above
E)a and b only

Question 15

A possible bad implication of asset securitization to the issuer is

A)the issuer can avoid regulatory taxes and therefore violates the spirit of banking regulation.
B)the quality of the issuer's assets may deteriorate since the issuer would be more likely to securitize the most liquid assets.
C)the issuer is subject to a higher capital and reserve requirements.
D)the issuer directly competes with investment banks that may have more expertise in dealing with capital market.
E)none of the above

Question 16

Which of the following statements is false?

A)A credit enhancement of a pass-through is usually provided by posting excess collateral and/or through an insurance bond purchased by the originator.
B)With a credit enhancement, the guarantor trust stands to collect from the credit enhancer an amount to cover losses due to defaults up to a specified coverage.
C)With a credit enhancement, a pass-through instrument is free of default risk.
D)The level of enhancement coverage is determined by a credit rating agency.
E)None of the above.

Question 17

As a pricing tool, securitization provides

A)the bank with a more accurate estimate of funding costs.
B)the bank with a better way to diversify its loan portfolio
C)the bank with a better way to stay competitive
D)a and b only
E)a and c only

Question 18

The main difference between loan sales and securitization is

A)loan sales involve a transfer of ownership while securitization merely alters the cash flow patterns of an asset
B)loan sales are always made with explicit recourse to the seller while securitization is made with or without recourse
C)loan sales are usually transferred from one bank to another while securitization involves selling the securitized assets to capital market participants.
D)all of the above
E)a and c only

Question 19

Which of the following statements is false about an Asset-backed Commercial Paper ABCP)?

A)Unlike the regular commercial paper, an ABCP is secured by the issuer's assets.
B)An ABCP is cheaper than a regular commercial paper because an ABCP helps to reduce moral hazard.
C)An ABCP is cheaper than a bank loan because an ABCP does not need to meet the capital requirement.
D)An ABCP typically comes with a credit enhancement.
E)None of the above

Question 20

In a dynamic pool pass-through,

A)the debt obligations in the pool have a revolving structure.
B)the debt obligations in the pool normally have a longer average life then the stated maturity of claims issued against the pool
C)the proceeds will be reinvested for a fixed time period when the loans mature.
D)all of the above
E)a and c only

Question 21

Use the following information for questions
Suppose that the Second United Bank has originated a portfolio of loans.The bank knows that the aggregate payoff on this portfolio call this portfolio S) will be $250 with probability 0.8 and $80 with probability 0.2.However, investors are unable to distinguish portfolio S from portfolio R.Portfolio R has an aggregate payoff of $250 with probability 0.6 and $80 with probability 0.4.Nevertheless, the investors believe that there is a 0.5 probability that the portfolio is S.The cost of communicating the true value of the portfolio is $18.If the bank keeps the portfolio on the books, its net profit is 3% of the true value minus a fixed cost of $2.50.The bank's net profit from origination and servicing is 2% of the value of the securitized portfolio.Everybody is risk-neutral.

-What is the bank's net profit from funding the loans and keeping them on the books?

A)$1.78
B)$3.98
C)$5.89
D)$7.88
E)$9.76

Question 22

What is the bank's repayment to the uninsured depositor?

A)$29.87
B)$30.60
C)$31.39
D)$38.66
E)$41.22

Question 23

Given the answer in 38, what is the expected value of the bank's shareholders?

A)$34.65
B)$55.78
C)$68.81
D)$77.69
E)$90.26

Question 24

Use the following information for questions
Suppose that the Second United Bank has originated a portfolio of loans.The bank knows that the aggregate payoff on this portfolio call this portfolio S) will be $250 with probability 0.8 and $80 with probability 0.2.However, investors are unable to distinguish portfolio S from portfolio R.Portfolio R has an aggregate payoff of $250 with probability 0.6 and $80 with probability 0.4.Nevertheless, the investors believe that there is a 0.5 probability that the portfolio is S.The cost of communicating the true value of the portfolio is $18.If the bank keeps the portfolio on the books, its net profit is 3% of the true value minus a fixed cost of $2.50.The bank's net profit from origination and servicing is 2% of the value of the securitized portfolio.Everybody is risk-neutral.

-What is the bank's net profit from securitization without communication?

A)$1.57
B)$3.98
C)$4.28
D)$5.66
E)$8.75

Question 25

Use the following information for questions
Suppose that the Third United Bank has originated a portfolio of loans.The bank knows that the aggregate payoff on this portfolio call this portfolio S) will be $1,000 with probability 0.7 and $400 with probability 0.3.However, investors are unable to distinguish portfolio S from portfolio R.Portfolio R has an aggregate payoff of $1,000 with probability 0.5 and $400 with probability 0.5.Nevertheless, the investors believe that there is a 0.5 probability that the portfolio is S.The cost of communicating the true value of the portfolio is $75.If the bank keeps the portfolio on the books, its net profit is 7% of the true value minus a fixed cost of
$25.The bank's net profit from origination and servicing is 4% of the value of the securitized portfolio.Everybody is risk-neutral.
Given the answer in 21, should the bank securitize the portfolio with or without communication compare the net payoff)?

A)With communication, since it is better off by $15.
B)With communication, since it is better off by $20.
C)With communication, since it is better off by $60.
D)Without communication, since it is better off by $15.
E)Without communication, since it is better off by $45.

Question 26

Use the following information for questions
Suppose that the Third United Bank has originated a portfolio of loans.The bank knows that the aggregate payoff on this portfolio call this portfolio S will be $1,000 with probability 0.7 and $400 with probability 0.3.However, investors are unable to distinguish portfolio S from portfolio R.Portfolio R has an aggregate payoff of $1,000 with probability 0.5 and $400 with probability 0.5.Nevertheless, the investors believe that there is a 0.5 probability that the portfolio is S.The cost of communicating the true value of the portfolio is $75.If the bank keeps the portfolio on the books, its net profit is 7% of the true value minus a fixed cost of
$25.The bank's net profit from origination and servicing is 4% of the value of the securitized portfolio.Everybody is risk-neutral.

-Whata.is the bank's net profit from funding the loans and keeping them on the books?

A)$56.00
B)$40.88
C)$32.40
D)$28.60
E)$25.76

Question 27

Assuming conventional financing with deposits), what is the insurance premium?

A)$14.27
B)$18.66
C)$22.38
D)$25.76
E)$27.44

Question 28

Use the following information for questions
Suppose that the Third United Bank has originated a portfolio of loans.The bank knows that the aggregate payoff on this portfolio call this portfolio S) will be $1,000 with probability 0.7 and $400 with probability 0.3.However, investors are unable to distinguish portfolio S from portfolio R.Portfolio R has an aggregate payoff of $1,000 with probability 0.5 and $400 with probability 0.5.Nevertheless, the investors believe that there is a 0.5 probability that the portfolio is S.The cost of communicating the true value of the portfolio is $75.If the bank keeps the portfolio on the books, its net profit is 7% of the true value minus a fixed cost of
$25.The bank's net profit from origination and servicing is 4% of the value of the securitized portfolio.Everybody is risk-neutral.
What is the value of the pooled portfolio i.e., if the bank securitize the portfolio without communication)?

A)$820
B)$800
C)$760
D)$745
E)$700

Question 29

Use the following information for questions
Suppose that the First United Bank of America has two loans.Each is due to be repaid one period hence and has independent and identically distributed cash flows.Each loan will repay $300 with probability 0.8 and $150 with probability 0.2.However, while the bank knows this, the investors cannot distinguish this loan from that of the Third TransAmerica Bank which has the same number of loans, but will pay $300 with probability 0.5 and $150 with probability 0.5.There is a prior belied of 0.5 that the First United Bank of America has the higher-valued portfolio.Suppose that the First United wished to securitize these loans, and if it does so without a credit enhancement, the cost of communicating the true value is 7.5% of the true value.Assume that the discount rate is zero and that everybody is risk-neutral.

-What is the net payoff if the First United communicates the true value of class B bonds?

A)$765
B)$653
C)$522
D)$495
E)$420

Question 30

Use the following information for questions
Suppose that the Third United Bank has originated a portfolio of loans.The bank knows that the aggregate payoff on this portfolio call this portfolio S will be $1,000 with probability 0.7 and $400 with probability 0.3.However, investors are unable to distinguish portfolio S from portfolio R.Portfolio R has an aggregate payoff of $1,000 with probability 0.5 and $400 with probability 0.5.Nevertheless, the investors believe that there is a 0.5 probability that the portfolio is S.The cost of communicating the true value of the portfolio is $75.If the bank keeps the portfolio on the books, its net profit is 7% of the true value minus a fixed cost of
$25.The bank's net profit from origination and servicing is 4% of the value of the securitized portfolio.Everybody is risk-neutral.

-Suppose the cost of communication drops to $12.Should the bank securitize the loans with communication relative to funding and keeping them on the books?

A)Yes, this generates a net profit of $28.62.
B)Yes, this generates a net profit of $32.84.
C)Yes, this generates a net profit of $42.75.
D)No, this generates a net profit of $32.32.
E)No, this generates a net profit of $44.65.

Question 31

Use the following information for questions
Suppose that the First United Bank of America has two loans.Each is due to be repaid one period hence and has independent and identically distributed cash flows.Each loan will repay $300 with probability 0.8 and $150 with probability 0.2.However, while the bank knows this, the investors cannot distinguish this loan from that of the Third TransAmerica Bank which has the same number of loans, but will pay $300 with probability 0.5 and $150 with probability 0.5.There is a prior belied of 0.5 that the First United Bank of America has the higher-valued portfolio.Suppose that the First United wished to securitize these loans, and if it does so without a credit enhancement, the cost of communicating the true value is 7.5% of the true value.Assume that the discount rate is zero and that everybody is risk-neutral.

-What is the net payoff to the First United if it communicates its private information to investors?

A)$655.75
B)$588.50
C)$535.85
D)$515.00
E)$499.50

Question 32

Use the following information for questions
Suppose that the Second United Bank has originated a portfolio of loans.The bank knows that the aggregate payoff on this portfolio call this portfolio S) will be $250 with probability 0.8 and $80 with probability 0.2.However, investors are unable to distinguish portfolio S from portfolio R.Portfolio R has an aggregate payoff of $250 with probability 0.6 and $80 with probability 0.4.Nevertheless, the investors believe that there is a 0.5 probability that the portfolio is S.The cost of communicating the true value of the portfolio is $18.If the bank keeps the portfolio on the books, its net profit is 3% of the true value minus a fixed cost of $2.50.The bank's net profit from origination and servicing is 2% of the value of the securitized portfolio.Everybody is risk-neutral.

-What is the value of the pooled portfolio i.e., if the bank securitize the portfolio without communication?

A)$216
B)$208
C)$199
D)$86
E)$80

Question 33

Use the following information for questions
Suppose that the First United Bank of America has two loans.Each is due to be repaid one period hence and has independent and identically distributed cash flows.Each loan will repay $300 with probability 0.8 and $150 with probability 0.2.However, while the bank knows this, the investors cannot distinguish this loan from that of the Third TransAmerica Bank which has the same number of loans, but will pay $300 with probability 0.5 and $150 with probability 0.5.There is a prior belied of 0.5 that the First United Bank of America has the higher-valued portfolio.Suppose that the First United wished to securitize these loans, and if it does so without a credit enhancement, the cost of communicating the true value is 7.5% of the true value.Assume that the discount rate is zero and that everybody is risk-neutral.

-What is the market value of the class B bonds?

A)$255
B)$240
C)$215
D)$195
E)$105

Question 34

Use the following information for questions
Suppose that the First United Bank of America has two loans.Each is due to be repaid one period hence and has independent and identically distributed cash flows.Each loan will repay $300 with probability 0.8 and $150 with probability 0.2.However, while the bank knows this, the investors cannot distinguish this loan from that of the Third TransAmerica Bank which has the same number of loans, but will pay $300 with probability 0.5 and $150 with probability 0.5.There is a prior belied of 0.5 that the First United Bank of America has the higher-valued portfolio.Suppose that the First United wished to securitize these loans, and if it does so without a credit enhancement, the cost of communicating the true value is 7.5% of the true value.Assume that the discount rate is zero and that everybody is risk-neutral.

-What is the true value of the First United's loan portfolio?

A)$1,080
B)$860
C)$740
D)$540
E)$380

Question 35

Use the following information for questions
Suppose that the Second United Bank has originated a portfolio of loans.The bank knows that the aggregate payoff on this portfolio call this portfolio S) will be $250 with probability 0.8 and $80 with probability 0.2.However, investors are unable to distinguish portfolio S from portfolio R.Portfolio R has an aggregate payoff of $250 with probability 0.6 and $80 with probability 0.4.Nevertheless, the investors believe that there is a 0.5 probability that the portfolio is S.The cost of communicating the true value of the portfolio is $18.If the bank keeps the portfolio on the books, its net profit is 3% of the true value minus a fixed cost of $2.50.The bank's net profit from origination and servicing is 2% of the value of the securitized portfolio.Everybody is risk-neutral.

-Suppose the cost of communication drops to $5.Should the bank securitize the loans with communication relative to funding and keeping them on the books?

A)Yes, this generates a net profit of $3.58.
B)Yes, this generates a net profit of $4.22.
C)Yes, this generates a net profit of $5.76.
D)No, this generates a net loss of $3.98.
E)No, this generates a net loss of $6.88.

Question 36

Use the following information for questions
Suppose that the Second United Bank has originated a portfolio of loans.The bank knows that the aggregate payoff on this portfolio call this portfolio S) will be $250 with probability 0.8 and $80 with probability 0.2.However, investors are unable to distinguish portfolio S from portfolio R.Portfolio R has an aggregate payoff of $250 with probability 0.6 and $80 with probability 0.4.Nevertheless, the investors believe that there is a 0.5 probability that the portfolio is S.The cost of communicating the true value of the portfolio is $18.If the bank keeps the portfolio on the books, its net profit is 3% of the true value minus a fixed cost of $2.50.The bank's net profit from origination and servicing is 2% of the value of the securitized portfolio.Everybody is risk-neutral.

-Given the answer in 21, should the bank securitize the portfolio with or without communication compare the net payoff?

A)With communication, since it is better off by $18.
B)With communication, since it is better off by $9.
C)With communication, since it is better off by $8.
D)Without communication, since it is better off by $1.
E)Without communication, since it is better off by $6.

Question 37

Use the following information for questions
Suppose that the First United Bank of America has two loans.Each is due to be repaid one period hence and has independent and identically distributed cash flows.Each loan will repay $300 with probability 0.8 and $150 with probability 0.2.However, while the bank knows this, the investors cannot distinguish this loan from that of the Third TransAmerica Bank which has the same number of loans, but will pay $300 with probability 0.5 and $150 with probability 0.5.There is a prior belied of 0.5 that the First United Bank of America has the higher-valued portfolio.Suppose that the First United wished to securitize these loans, and if it does so without a credit enhancement, the cost of communicating the true value is 7.5% of the true value.Assume that the discount rate is zero and that everybody is risk-neutral.

-What is the market value of the securitized loan if the First United does not communicate any information to investors?

A)$1,078
B)$540
C)$495
D)$365
E)$300

Question 38

Use the following information for questions
Suppose that the First United Bank of America has two loans.Each is due to be repaid one period hence and has independent and identically distributed cash flows.Each loan will repay $300 with probability 0.8 and $150 with probability 0.2.However, while the bank knows this, the investors cannot distinguish this loan from that of the Third TransAmerica Bank which has the same number of loans, but will pay $300 with probability 0.5 and $150 with probability 0.5.There is a prior belied of 0.5 that the First United Bank of America has the higher-valued portfolio.Suppose that the First United wished to securitize these loans, and if it does so without a credit enhancement, the cost of communicating the true value is 7.5% of the true value.Assume that the discount rate is zero and that everybody is risk-neutral.

-Suppose now the First United can find a credit enhancer.With credit enhancement, class B bondholders can be guaranteed to receive $300.The market for credit enhancement is competitive.Ignoring the possibility of default by the credit enhancer, how much will the First United have to pay the credit enhancer?

A)$122
B)$75
C)$68
D)$60
E)$42

Question 39

Use the following information for questions
Suppose that the First United Bank of America has two loans.Each is due to be repaid one period hence and has independent and identically distributed cash flows.Each loan will repay $300 with probability 0.8 and $150 with probability 0.2.However, while the bank knows this, the investors cannot distinguish this loan from that of the Third TransAmerica Bank which has the same number of loans, but will pay $300 with probability 0.5 and $150 with probability 0.5.There is a prior belied of 0.5 that the First United Bank of America has the higher-valued portfolio.Suppose that the First United wished to securitize these loans, and if it does so without a credit enhancement, the cost of communicating the true value is 7.5% of the true value.Assume that the discount rate is zero and that everybody is risk-neutral.

-How much can the claims to the class A bondholders be sold for?

A)$450
B)$420
C)$300
D)$280
E)$220

Question 40

Use the following information for questions
Suppose that the Third United Bank has originated a portfolio of loans.The bank knows that the aggregate payoff on this portfolio call this portfolio S) will be $1,000 with probability 0.7 and $400 with probability 0.3.However, investors are unable to distinguish portfolio S from portfolio R.Portfolio R has an aggregate payoff of $1,000 with probability 0.5 and $400 with probability 0.5.Nevertheless, the investors believe that there is a 0.5 probability that the portfolio is S.The cost of communicating the true value of the portfolio is $75.If the bank keeps the portfolio on the books, its net profit is 7% of the true value minus a fixed cost of
$25.The bank's net profit from origination and servicing is 4% of the value of the securitized portfolio.Everybody is risk-neutral.
What is the bank's net profit from securitization without communication?

A)$56.00
B)$45.64
C)$40.88
D)$32.40
E)$30.40

Question 41

Given the answers in 42-44, what is the NPV to the bank's shareholders?

A)$25.68
B)$32.55
C)$35.12
D)$37.19
E)$41.28

Question 42

Given the answers in 42 and 43, what is the bank's total repayment obligation?

A)$56.00
B)$78.87
C)$85.87
D)$87.39
E)$101.68

Question 43

Given the answers in 39 and 40, what is the NPV to the bank's shareholders?

A)$12.38
B)$27.64
C)$30.98
D)$37.16
E)$45.43

Question 44

If the bank uses a securitized bond financing, what is the amount of promised repayment to the securitized bondholders?

A)$29.87
B)$31.22
C)$38.77
D)$45.63
E)$48.79

Question 45

Given the scenario is question 42, what is the deposit insurance premium?

A)$9.78
B)$14.93
C)$16.77
D)$18.96
E)$21.22