Question 1

Which of the following statements is true?

Accepted Answer

Zero-coupon bonds are bonds that do not pay any coupon or interest during the life of the bond. Hence, there are no intervening cash flows between issue and maturity. Because of this, these bonds usually sell at a discount from face value. The discount is equivalent to the interest that would have been earned if the bond had paid coupon payments.

Question 2

A buyer of a loan participation is exposed to:

Accepted Answer

A buyer of a loan participation is exposed to both the risk of the original borrower defaulting and the risk of the selling bank failing. If the original borrower defaults, the buyer may not receive the full amount of the loan participation. If the selling bank fails, the buyer may not receive any payments at all. Additionally, there may be moral hazard problems if the borrower is no longer monitored by the seller.

Question 3

... is the creation of securities based on a pool of underlying assets; and the value and income payments of the created securities are derived from the underlying assets.

Accepted Answer

Asset securitisation involves creating securities that are backed by a pool of underlying assets. The income and value of these securities are derived from the performance of the underlying assets, which can include anything from mortgages to credit card debt. This process is commonly used in the finance industry to help companies diversify their funding sources and manage risk.

Question 4

Which of the following observations is not correct?

Accepted Answer

Most loans are actually sold without recourse, meaning the seller does not guarantee against losses from default.

Question 5

What are the two basic types of loan sale contracts or mechanisms by which loans can be transferred between seller and buyer?

Accepted Answer

The two basic types of loan sale contracts or mechanisms are participations and assignments. Participations involve the buyer purchasing a percentage of the loan and sharing in the risk and reward, while the seller remains the primary lender. Assignments involve the seller transferring the entire loan to the buyer, who becomes the primary lender. Option B is incorrect as originations refer to the process of creating a new loan, not transferring an existing one. Option C is incorrect as syndications involve multiple lenders joining together to provide financing, not the transfer of an existing loan. Option D is incorrect as transfers and assignments are essentially the same thing, with assignments being a specific type of transfer.

Question 6

Besides reducing credit risks, an FI has an incentive to sell loans it originates for all of the following reasons except to:

Accepted Answer

Selling loans allows financial institutions (FIs) to geographically diversify their loan portfolios, lower their reserve requirements by reducing the total amount of deposits they must hold in reserve, and lower capital requirements by transferring the risk associated with the loans. Decreasing core deposits is not a reason for selling loans; in fact, FIs typically aim to increase or maintain their core deposits as a stable source of funding.

Question 7

In a loan participation the holder (buyer):

Accepted Answer

The answer of In a loan participation the holder (buyer):
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Question 8

What is NOT true of loan assignments?

Accepted Answer

Loan assignments typically involve the transfer of all rights from the seller to the buyer, allowing the buyer to hold a direct claim on the borrower. Ownership rights become clearer through this process. However, the statement that contract terms are unrestrictive from the seller's perspective is not true. In fact, loan assignments often come with various restrictions and conditions that both parties must adhere to, making this statement incorrect.

Question 9

In Australia, a securitisation program must have:

Accepted Answer

The question outlines the requirements for a securitisation program in Australia. The best choice is option D as it includes all the criteria listed - specifically created SPV, resident in Australia, not required to provide data to APRA, and specific assets backing its liabilities in the form of debt securities. Option A is incorrect as it does not mention the requirement for specific assets. Option B is incorrect as it references ASIC instead of APRA, and may or may not be resident in Australia. Option C is incorrect as it does not mention the requirement for a specifically created SPV.

Question 10

Currently, this basic type of loan sale contracts comprises the bulk of loan sales trading.

Accepted Answer

Assignments refer to the transfer of ownership of a loan from one party to another. This is the most common type of loan sale contract and comprises the bulk of loan sales trading. Participations, originations, and syndications refer to different types of loan arrangements and are not necessarily related to loan sales trading.

Question 11

Which of the following is true concerning loans sold with recourse?

Accepted Answer

Loans sold with recourse means that the FI that originated the loan retains a contingent credit risk liability, meaning they will bear some responsibility if the loan goes bad. This is different from loans sold without recourse where the buyer assumes all credit risk. Most loans are not sold with recourse, making option A false. Option B is also false as the buyer can put the loan back to the selling FI in this scenario. Option C is also false as the FI does have explicit liability.

Question 12

Which of the following statements is false?

Accepted Answer

Default risk is the risk that the borrower is unwilling or unable to fulfil the terms promised under loan contract. Refinancing the loan before maturity is not related to default risk but rather to prepayment risk. Therefore, statement B is false.

Question 13

Loan participations are:

Accepted Answer

Loan participations are generally considered riskier than loan assignments because in a loan participation, the participant relies on the originating lender to service the loan and deal with the borrower, which adds an additional layer of risk compared to a loan assignment where the assignee typically assumes direct rights and responsibilities related to the loan.

Question 14

Which of the following is not true of a loan that is sold without recourse?

Accepted Answer

The FI that originated the loan bears all the credit risk.

Question 15

Loan participations are typically sold to correspondent banks because:

Accepted Answer

Correspondent banks offer the greatest monitoring opportunities as they are in an ongoing relationship with the original lender and have a vested interest in ensuring the repayment of the loan. Insider trust and regulatory requirements may be factors, but they are not the primary reason for selling loan participations to correspondent banks. Pricing may also be a consideration, but it is not the main reason for choosing correspondent banks as buyers.

Question 16

This propensity to prepay means:

Accepted Answer

Prepayment means that borrowers pay back their loans earlier than expected, which can cause realized coupons/cash flows on pass-through securities to deviate from the stated or expected coupon flows. Since a portion of the principal is being repaid early, this impacts the cash flow patterns of the securities. Therefore, choice B is the best option.

Question 17

....is a relationship between a small bank and a large bank in which the large bank provides a number of deposit, lending and other services.

Accepted Answer

A correspondent banking arrangement is a relationship between a small bank and a large bank in which the large bank provides a number of deposit, lending and other services to the small bank. This allows the small bank to offer a wider range of services to its customers without having to invest in additional resources to provide those services.

Question 18

Assignments:

Accepted Answer

Assignments are common in loan syndications, where one lender assigns its portion of the loan to another lender. This allows the assigning lender to reduce its exposure to the borrower while still retaining some involvement in the loan. However, assignments may still require some level of monitoring and oversight, so the monitoring costs may not necessarily be extremely high. Option B is incorrect because assignments can have buyer restrictions, such as restrictions on transferability or requirements for the assignee to meet certain qualifications or criteria. Option C is also incorrect as assignments can comprise a significant portion of the US loan sales market.

Question 19

The move towards market value accounting:

Accepted Answer

The answer of The move towards market value accounting:
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Question 20

A loan provided by a group of FIs as opposed to a single lender is called:

Accepted Answer

A syndicated loan is a loan provided by a group of financial institutions (FIs) to a borrower. It is typically used for large financing needs, such as for large projects or mergers and acquisitions. The participating FIs work together to pool their resources and share the risk of lending to the borrower.

Quiz 8: Managing Interest Rate Risk Using Securitisation