Question 1

Few securitization transactions that employ internal credit enhancements follow a predetermined schedule that prioritizes the manner in which principal and interest generated by the underlying collateral must be used.

Accepted Answer

Few securitization transactions that employ internal credit enhancements follow a predetermined schedule that prioritizes the manner in which principal and interest generated by the underlying collateral must be used. This statement is false because such transactions typically have predetermined schedules for the allocation of principal and interest.

Question 2

Securitization is a vehicle for raising funds directly in the public market without the need for a financial ________. That is, securitization is said to result in ________.

Accepted Answer

Securitization eliminates the need for an intermediary, such as a bank, to issue or sell the securities. This is known as financial disintermediation.

Question 3

In a securitization, a variety of third parties are involved including ________.

Accepted Answer

All of these third parties are commonly involved in a securitization. Credit guarantors (most commonly bond insurers) and the servicer play a key role in managing the credit risk of the underlying assets. A trustee and issuer's counsel are also typically involved to oversee the transaction and ensure compliance with legal requirements. Guaranteed investment contract providers and accountants may also be involved in certain cases to provide additional financial safeguards and advice.

Question 4

If there are a few borrowers in the pool that are significant in size relative to the entire pool balance, this diversification benefit can be lost, resulting in a higher level of credit risk referred to as ________.

Accepted Answer

Concentration risk refers to the heightened level of credit risk that arises when a few borrowers in a loan pool have a significant balance relative to the entire pool. This can be problematic because if any of these borrowers default, the impact on the overall pool can be substantial. Focus risk, concentric risk, and intensity risk are not commonly used industry terms to describe credit risk.

Question 5

External credit enhancements come in more complicated forms than internal credit enhancements and may alter the cash flow characteristics of the loans even in the absence of default.

Accepted Answer

The answer of External credit enhancements come in more complicated...

Question 6

Which of the below statements is FALSE?

Accepted Answer

The statement that "The concerns with the financial disintermediating impact of securitization are that more assets will be held in the portfolio of banks" is false. In fact, one of the concerns with securitization is that it can lead to less financial intermediation by banks, as they may choose to sell off their loans to investors through securitization rather than hold them on their balance sheet.

Question 7

Uncommon forms of internal credit enhancement are senior/subordinate structures, overcollateralization, and reserve funds.

Accepted Answer

Senior/subordinate structures, overcollateralization, and reserve funds are common forms of internal credit enhancement used to improve the credit profile of debt issuances.

Question 8

By making financial assets tradable in this way, securitization ________.

Accepted Answer

Securitization can reduce agency costs, as it creates a direct link between the borrower and investor, bypassing intermediaries such as banks. This can lead to a more efficient allocation of capital in the financial markets.

Question 9

Securitizations require credit enhancement and the mechanism for credit enhancing a structure are classified as internal and external.

Accepted Answer

This statement is true. Securitizations are often credit enhanced to improve the credit rating of the asset-backed securities. Credit enhancement mechanisms can be classified as internal (such as overcollateralization, subordination, and reserve funds) or external (such as financial guarantees, letters of credit, and insurance).

Question 10

Which of the below statements is TRUE?

Accepted Answer

This statement accurately describes what student loans are intended for. A) is false, as the SBA is indeed an agency of the U.S. government that guarantees loans. B) is false, as most SBA loans require both principal and interest payments. D) is false, as senior citizen loans are not a common type of loan and do not typically follow this payment structure.

Question 11

The key benefit of securitization to financial markets is that it ________.

Accepted Answer

Securitization allows for the creation of tradable securities with better liquidity for financial claims that would otherwise have remained in the portfolio of financial intermediaries and therefore highly illiquid. By pooling together similar assets and transforming them into securities, investors are provided with more diverse investment opportunities and the ability to easily buy and sell the securities. This results in increased liquidity for the market and a more efficient allocation of resources.

Question 12

The collateral in a securitization can be classified as either amortizing or nonamortizing assets.

Accepted Answer

This statement is true. Amortizing assets are those that generate regular cash flows (such as mortgage payments) that gradually pay down the principal amount, while nonamortizing assets do not have regular cash flows but may generate a one-time lump sum payment (such as a lottery win or legal settlement). The classification of collateral as amortizing or nonamortizing can affect the structure and pricing of a securitization.

Question 13

The SPV is the issuer of the ABS.

Accepted Answer

The Special Purpose Vehicle (SPV) is typically the issuer of Asset-Backed Securities (ABS). The role of an SPV is to hold the underlying assets of the ABS and issue the securities that represent a claim on the cash flows generated by those assets. Investors in the ABS are essentially investing in the cash flows generated by the underlying assets, rather than the creditworthiness of the SPV or its sponsors.

Question 14

In addition to the administration of the loan portfolio, the ________ is responsible for distributing the proceeds collected from the borrowers to the different bond classes in the structure according to the cash flow waterfall.

Accepted Answer

The servicer is specifically responsible for distributing the proceeds collected from the borrowers to the different bond classes in the structure according to the cash flow waterfall. The trustee may also have involvement in managing the loan portfolio and distributing proceeds, but this is not their primary responsibility. Bond insurers are not responsible for managing or servicing loans.

Question 15

The underlying principle of ________ is that a large number of borrowers in a pool will reduce the ________ via diversification.

Accepted Answer

The underlying principle of asset securitization is to pool together a large number of borrowers and their assets, and then sell securities backed by those assets to investors. This reduces the credit risk as the default risk is spread across a large pool of borrowers, which helps to diversify the risk.

Question 16

The competitive transition charge (CTC) is effectively a legislated asset and is the result of the movement to make the electric utility industry more competitive by deregulating the industry. In regards to CTC, which of the below statements is FALSE?

Accepted Answer

The statement that the CTC is collected over an unknown period of time is false. The CTC is collected over a specified number of years, typically 5-10 years, and is intended to cover the costs associated with stranded assets and other expenses the utility incurred as a result of deregulation.

Question 17

When unamortizing assets are securitized, the composition of the collateral is fixed over the life of the structure, all principal received by the trust is paid out to the bond classes and the securitization is said to be a self-liquidating structure.

Accepted Answer

When unamortizing assets are securitized, the composition of the collateral can change over the life of the structure due to the revolving period where new assets can be added. The principal received may be used to purchase new collateral rather than being paid out, making it not strictly a self-liquidating structure until it reaches the amortization phase.

Question 18

In considering the structure, the rating agencies will consider ________.

Accepted Answer

The rating agencies will consider how losses will be allocated among the bond classes in the structure because this will affect the risk of the bonds and, therefore, their rating.

Question 19

The SPV plays a critical role in a securitization because it legally separates the loans and receivables sold to the SPV from the originator and therefore reduces funding costs because investors look to the credit risk of the collateral rather than the credit risk of the originator.

Accepted Answer

This statement is true. The use of an SPV in securitization transactions helps to legally isolate the loans and receivables sold to the SPV, thereby reducing funding costs for the originator. Investors focus on the creditworthiness of the collateral backing the securities, rather than the credit risk of the originator.

Question 20

Investors in ABS are exposed to ________ and rely on ________ to evaluate that risk for the bond classes in a securitization.

Accepted Answer

Investors in ABS are primarily exposed to credit risk since the performance of the underlying assets determines the ability of the issuers to make payments to investors. Rating agencies assess the credit risk of the bond classes in a securitization, and investors rely on their evaluation to determine whether to invest in a particular ABS. While liquidity risk is also a consideration, it is not the primary exposure for ABS investors, and government agencies are not typically involved in evaluating ABS risk.

Quiz 25: Market for Asset-Backed Securities