fin 475 ch 9

A bank has placed 5,000 consumer loans in a package to be securitized. These loans have an annual yield of 15.25 percent. The bank estimates that the securities on these loans are priced to yield 10.95 percent. The bank's default (charge-off) rate on the pooled loans is expected to be 1.45 percent. Underwriting and advisory services will cost 0.25 percent, and a credit guarantee, if more loans default than expected, will cost 0.35 percent. What is the residual income from this loan securitization? A. 3.70 percent B. 4.30 percent C. 2.25 percent D. 5.15 percent E. None of the options is correct

C. 2.25 percent

A group of loans pooled for securitization is expected to yield a return of 23%. The coupon rate promised to investors on securities issued against the pool of loans is 8%. The default (charge-off) rate on the pooled loans is expected to be 4.5%. The fee to compensate a servicing institution for collecting payments on the loans is 2%. Fees to set up credit and liquidity enhancements are 3%. The fee for advice on how to set up the pool of securitized loans is 1%. What is the residual income on this pool of loans? A. 18.5% B. 9% C. 4.5% D. 2% E. None of the options is correct

C. 4.5%

Most loans sold in the open market usually mature within _______. A. 30 days B. 60 days C. 90 days D. 180 days E. 360 days

C. 90 days

The coupon rate promised to investors on securities issued against a pool of loans is 6.5%. The default rate on the pool of loans is expected to be 3.5%. The fee to compensate a servicing institution for collecting payments on the loan is 2%. Fees to set up credit and liquidity enhancements are 5%. The residual income on this pool of loans is 7%. What is the expected yield on this pool of loans? A. 24% B. 12% C. 10% D. 6.5% E. None of the options is correct.

A. 24%

What prompted a surge in loan sales in the 1980s? A. A wave of corporate buyouts B. An increase in lesser-developed country loans C. A loosening of government regulations D. An increase in international lending E. None of the options is correct

A. A wave of corporate buyouts

A financial institution plans to issue a group of bonds backed by a pool of automobile loans. However, they fear that the default rate on the automobile loans will rise well above 4 percent of the portfolio—the projected default rate. The financial institution wants to lower the interest payments if the loan default rate rises too high. Which type of credit derivative contract would you most recommend for this situation? A. Credit-linked note B. Credit option C. Credit risk option D. Total-return swap E. Credit swap

A. Credit-linked note

Which of the following developed a new mortgage-backed instrument—the collateralized mortgage obligation (CMO)—in which investors were offered different classes of mortgage-backed securities with different expected payout schedules? A. Freddie Mac B. Fannie Mae C. Ginnie Mae D. Credit Suisse E. Federal Housing Administration

A. Freddie Mac

If P is the price of the standby, NL is the cost of a nonguaranteed loan, and GL is the cost of a loan backed by a standby guarantee, then a borrower is likely to seek an SLC if: A. P < (NL - GL). B. P > (NL - GL). C. P = (NL - GL). D. P < (NL + GL). E. P > (NL + GL).

A. P < (NL - GL).

A bank that wants to protect itself from higher borrowing costs due to a decrease in its credit rating might purchase: A. a credit risk option. B. a standby letter of credit. C. a credit linked note. D. a credit swap. E. None of the options is correct

A. a credit risk option.

The party for whom a standby credit letter is issued by a bank is known as the: A. account party. B. beneficiary. C. representative. D. credit guarantor. E. None of the options is correct.

A. account party.

Loan sales by banks are generally of two types: (a) participation loans; and (b) _________. The term that correctly fills in the blank above is: A. assignments B. recourse loans C. direct loans D. subscription loans E. None of the options is correct

A. assignments

The Government National Mortgage Association (GNMA, or Ginnie Mae): A. guarantees the issuance of securities by private lenders. B. creates its own mortgage-backed securities. C. acquires pools of home-mortgage loans from private lenders. D. developed a new mortgage-backed instrument—the CMO. E. is not a government-sponsored enterprise.

A. guarantees the issuance of securities by private lenders.

According to research, off-balance-sheet standby credit letters reduce risk by: A. increasing the diversification of assets. B. reducing the need for documentation. C. reducing probability of losses. D. avoiding capital requirements. E. increasing concentration of risk exposure.

A. increasing the diversification of assets.

When an issuer of securitized loans divides them into different risk classes or tranches, they are providing an: A. internal credit enhancement B. external credit enhancement C. internal liquidity enhancement D. external liquidity enhancement E. None of the options is correct.

A. internal credit enhancement

When an issuer of securitized loans sets aside a cash reserve to cover loan defaults, they are providing an: A. internal credit enhancement. B. external credit enhancement. C. internal liquidity enhancement. D. external liquidity enhancement. E. None of the options is correct

A. internal credit enhancement.

In a loan strip, the risk of the borrower default: A. is retained by the seller. B. is transferred to an SPE. C. is transferred to the buyer. D. is negligible and therefore, a non-issue. E. is very high and always secured by a credit-default swap.

A. is retained by the seller.

A bank or any other lender whose loans are pooled is called: A. the originator. B. the special-purpose entity. C. the trustee. D. the servicer. E. the credit enhancer.

A. the originator.

A bank is about to make a $50 million project loan to develop a new oil field and is worried that the petroleum engineer's estimates of the yield on the field are incorrect. The bank wants to protect itself in case the developer cannot repay the loan. Which type of credit derivative contract would you most recommend for this situation? A. Credit-linked note B. Credit option C. Credit risk option D. Total-return swap E. Credit swap

B. Credit option

A bank has a long-term relationship with a particular business customer. However, recently the bank has become concerned because of a potential deterioration in the customer's income. In addition, regulators have expressed concerns about the bank's capital position. The business customer has asked for a renewal of its $25 million dollar loan with the bank. Which of the following can be used to help this situation? A. Standby letter of credit B. Loan sale C. Loan securitization D. Credit risk option E. Credit-linked notes

B. Loan sale

Which of the following is an advantage of using loan-backed bonds for a bank? A. Loans used as collateral for the bonds can be sold before the maturity of the bonds B. Loan-backed bonds have longer maturities than deposits C. Banks do not have to meet regulatory capital requirements on loans used as collateral D. Banks can use fewer loans as collateral than the amount of bonds issued E. All the options are advantages of loan-backed bonds

B. Loan-backed bonds have longer maturities than deposits

Which of the following is a risk of using credit derivatives? A. Credit derivatives do not protect against credit risk exposure. B. The partner in a swap or an option contract may fail to perform. C. Regulators may decide to lower the amount of capital needed for banks using these derivatives. D. Regulators may decide that these derivatives make the bank more stable and efficient. E. All the options are risks of using credit derivatives

B. The partner in a swap or an option contract may fail to perform.

Which of the following is true regarding regulatory rules for standby credit letters issued by banks? A. They must list the standby credit letter as a liability on their balance sheet B. They must count standby credit letters as loans when assessing how risk-exposed the institution is to a single customer C. They do not have to apply the same credit standards for approving standby credit letters as direct loans D. They can apply lower capital standards to standbys than loans E. They must provide capital reserve against issued standby letters of credit

B. They must count standby credit letters as loans when assessing how risk-exposed the institution is to a single customer

Loans that are to be securitized are passed on to ____________. This helps ensure that if the lender goes bankrupt, it does not affect the credit status of the pooled loans. A. the originator B. a special-purpose entity C. the trustee D. a servicer E. the credit enhancer

B. a special-purpose entity

When a bank issues a standby credit guarantee on behalf of one of its customers, the party receiving the guarantee is known as the: A. account party. B. beneficiary. C. obligator. D. servicing agent. E. None of the options is correct.

B. beneficiary.

When an issuer of securitized loans includes a standby letter of credit with the securitized loans, they are providing an: A. internal credit enhancement. B. external credit enhancement. C. internal liquidity enhancement. D. external liquidity enhancement. E. None of the options is correct.

B. external credit enhancement.

Credit ratings for loan-backed bonds are often: A. lower than the issuing institution. B. higher than the issuing institution. C. at par with the issuing institution. D. based on the total loans issued by the bank. E. based on the assets under management of the bank.

B. higher than the issuing institution.

In some instances, banks sell loans and agree to give the loan purchaser recourse to the seller for all or a portion of those loans that become delinquent. In this case, the purchaser, in effect, gets a: A. call option. B. put option. C. forward contract. D. futures contract. E. None of the options is correct.

B. put option.

Securitization had its origin in the selling of securities backed by ____________. A. credit card receivables B. residential mortgage loans C. computer leases D. automobile loans E. truck leases

B. residential mortgage loans

The difference in interest rates between securitized loans themselves and the securities issued against the loans is referred to as: A. the funding gap. B. residual income. C. service returns. D. security income. E. None of the options is correct.

B. residual income.

A bank plans to offer new subordinated notes in the open market next month but knows that its credit rating is being reviewed by a credit rating agency. The bank wants to avoid paying sharply higher credit costs. Which type of credit derivative contract would you most recommend for this situation? A. Credit-linked note B. Credit option C. Credit risk option D. Total-return swap E. Credit swap

C. Credit risk option

Banks that issue standby letters of credit may face which of the following types of risk? A. Prepayment risk B. Interest-rate risk C. Liquidity risk D. Options B and C only E. All the options are correct.

C. Liquidity risk

Which of the following is a disadvantage of using loan-backed bonds for a bank? A. The cost of funding often rises B. There is greater default risk on the bonds C. Loans used as collateral for the bonds must be held until the bonds reach maturity D. Loan-backed bonds have shorter maturities than deposits E. All the options are disadvantages of loan-backed bonds

C. Loans used as collateral for the bonds must be held until the bonds reach maturity

Which of the following is a way to reduce the risk of standby credit letters? A. Avoid renegotiating the terms of loans of SLC customers B. Specialize in SLCs issued by the same region and industry C. Selling participations in standbys in order to share risk with other lending institutions D. Do not count standbys as loans when assessing the bank's risk exposure E. All the options are ways to reduce the risk of standby credit letters

C. Selling participations in standbys in order to share risk with other lending institutions

Which of the following is true regarding regulatory rules for standby credit letters issued by banks? A. They must list the standby credit letter as a liability on their balance sheet B. They do not have to list standby credit letters when assessing the risk exposure to a single credit customer C. They must apply the same credit standards for approving standby credit letters as direct loans D. They can apply lower capital standards to standby credit letters than loans E. None of the options is true

C. They must apply the same credit standards for approving standby credit letters as direct loans

A hybrid instrument which allows the issuer to lower its coupon payments if some significant factor changes is called: A. a credit option. B. a standby letter of credit. C. a credit-linked note. D. a credit swap. E. None of the options is correct.

C. a credit-linked note.

For an issuer, a standby credit letter is a(n): A. securitized strip. B. loan strip. C. contingent obligation. D. indirect loan. E. None of the options is correct.

C. contingent obligation.

By agreeing to service any assets that are packaged together in the securitization process a bank can: A. ensure the assets that are packaged and securitized remain in the package and are not sold off. B. choose the best loans to go through the securitization process. C. earn added fee income. D. liquidate any assets it chooses. E. None of the options is correct.

C. earn added fee income.

Short-dated pieces of a longer-term loan, usually maturing in a few days or weeks, are called: A. loan participations. B. servicing rights. C. loan strips. D. shared credits. E. None of the options is correct.

C. loan strips.

The lesson(s) of the credit crisis of 2007-2009 is that the "bankruptcy remote" arrangement of the special-purpose entity (SPE): A. reduces the need for securitization. B. eliminates the probability of bankruptcy of the originator institution. C. may create problems if the underlying loans go bad in great numbers. D. eliminates the need for a trustee. E. All of the options are correct.

C. may create problems if the underlying loans go bad in great numbers.

In a securitization process, someone appointed to ensure that the issuer fulfills all the requirements of transfer of loans to the pool, and provides all of the services promised to investors in the securities is called: A. the originator. B. the special-purpose entity. C. the trustee. D. the servicer. E. the credit enhancer.

C. the trustee.

According to the text, in 2005 the securitization of loans reached: A. million dollar market. B. billion dollar market. C. trillion dollar market. D. market unknown in value. E. small but growing market.

C. trillion dollar market.

According to the textbook, what is the minimum size of the loan-backed securities offerings that are likely to be successful? A. $1 million B. $10 million C. $25 million D. $100 million E. $1 trillion

D. $100 million

Why are securitized loans often issued through a special-purpose entity? A. Because the securitized loans often add risk to the bank and need to be held separately B. Because the securitized loans are not profitable for the bank and need to be held separately C. Because the special-purpose entity might fail and this prevents the failure of the bank D. Because the bank might fail and this protects the credit status of the securitized loans E. All of the options are correct

D. Because the bank might fail and this protects the credit status of the securitized loans

Which of the following is a reason for standby credit letters' growth in the recent years? A. The growth of bank loans sought by companies in recent years B. The decreased demand for risk-reduction devices C. Regulatory embargo on traditional lenders D. The rapid growth of direct financing by companies E. All of the options are correct

D. The rapid growth of direct financing by companies

A bank is concerned about excess volatility in its cash flows from some recent business loans it has made. Many of these loans have a fixed rate of interest and the bank's economics department has forecast a sharp increase in interest rates. The bank wants more stable cash flows. Which type of credit derivative contract would you most recommend for this situation? A. Credit-linked note B. Credit option C. Credit risk option D. Total-return swap E. Credit swap

D. Total-return swap

When two banks simply agree to exchange a portion of their customers' loan repayments, they are using: A. a credit option. B. a standby letter of credit. C. a credit linked note. D. a credit swap. E. None of the options is correct.

D. a credit swap.

The principal sellers of risk protection via credit derivatives include all of the following except: A. insurance companies. B. securities dealers. C. fund management firms. D. banks. E. None of the options is correct.

D. banks.

If a credit letter is issued to backstop payments on loan-backed securities, the credit letter is a form of: A. collateralized asset. B. residual income. C. direct loan obligation. D. credit enhancement. E. None of the options is correct.

D. credit enhancement.

Loan-backed securities, which closely resemble traditional bonds, carry various forms of credit enhancements, which may include all of the following, except: A. credit letter guaranteeing repayment of the securities. B. set aside of a cash reserve. C. division into different risk classes. D. early payment clauses. E. None of the options is correct.

D. early payment clauses.

Catastrophe-linked securities ("cat bonds") have been developed to shift risk from ________ to the financial markets. A. real-estate developers B. bankers C. oil companies engaged in mid-sea explorations D. insurers E. rating agencies

D. insurers

In a collateralized mortgage obligation (CMO), a tranche: A. promises a different return (coupon) to investors. B. acts as a liquidity enhancement. C. carries a different risk exposure. D. options A and C are correct. E. All of the options are correct.

D. options A and C are correct.

Securitized assets carry a unique form of risk called: A. default risk. B. inflation risk. C. interest-rate risk. D. prepayment risk. E. None of the options is correct.

D. prepayment risk.

Someone who collects the payments on the securitized loans and passes on those payments to the trustee is called: A. the originator. B. the special-purpose entity. C. the trustee. D. the servicer. E. the credit enhancer.

D. the servicer.

Which of the following is a concern regulators have about securitization? A. The risk of being an underwriter for asset-backed securities that cannot be sold B. The risk of acting as a credit enhancer and underestimating the need for loan-loss reserves C. The risk that unqualified trustees will fail to protect investors in asset-backed instruments D. The risk that loan servicers will be unable to satisfactorily monitor loan performance E. All of the options are concerns regulators have about securitization

E. All of the options are concerns regulators have about securitization

The lesson from the credit crisis of 2007-2009 is that securitized assets and credit swaps: A. are complex financial instruments. B. are difficult to correctly value and measure in terms of risk exposure. C. are a part of cyclically sensitive markets. D. possible vehicles to set in motion a financial contagion that cannot be easily stopped without active government intervention. E. All of the options are correct.

E. All of the options are correct.

Saleable loans appear to have several advantages over bonds for many investors due to: A. strict loan covenants. B. floating interest rates. C. market for shorter maturity loans. D. market for longer maturity bonds. E. All the options are advantages of saleable loans over bonds.

E. All the options are advantages of saleable loans over bonds.

Which of the following is an advantage of securitizing loans? A. Diversifying a lender's credit risk exposure B. Reducing the need to monitor each individual loan's payment stream C. Transforming illiquid assets into liquid securities D. Serving as a new source of funds for lenders and attractive investments for investors E. All the options are advantages of securitizing loans

E. All the options are advantages of securitizing loans

Securitization is used by the banks to: A. fund a portion of a loan portfolio. B. allocate capital more efficiently. C. diversify funds sources. D. lower the cost of fund raising. E. All the options are correct.

E. All the options are correct.

Which of the following is a key advantage(s) of issuing standby letters of credit? A. Letters of credit generate fee income for the bank. B. Letters of credit typically reduce the borrower's cost of borrowing. C. Letters of credit can usually be issued for a relatively low cost. D. The probability is low that the issuer of the letter of credit will be called upon to pay. E. All the options are correct.

E. All the options are correct.

A bank has a limited geographic area of operations. It would like to diversify its loan income with loans in other market areas but does not want to actually make loans in those areas because of its limited experience in those areas. Which type of credit derivative contract would you most recommend for this situation? A. Credit-linked note B. Credit option C. Credit risk option D. Total return swap E. Credit swap

E. Credit swap

Which of the following is an advantage of credit swaps for each partner? A. Broaden the number of markets B. Broaden the variety of markets from which they collect loan revenues and principal C. Spread out the risk in the loan portfolio D. Avoiding capital requirements E. Options A, B, and C are all advantages of a credit swap for each partner.

E. Options A, B, and C are all advantages of a credit swap for each partner.

Investors in securitized loans normally receive added assurance that they will be repaid in the form of guarantees against default issued by: A. the originator. B. the special-purpose entity. C. the trustee. D. the servicer. E. a credit enhancer.

E. a credit enhancer.

A securitized asset where the asset used to back the securities is a loan based on the residual value of a homeowner's residence is called: A. a mortgage-backed security. B. a credit-card-backed security. C. an automobile-backed security. D. a loan-backed bond. E. a home-equity-loan-backed-security.

E. a home-equity-loan-backed-security.

Bonds backed by pools of home equity loans often carry higher yields than other loan-backed securities because of their substantial: A. market risk. B. credit risk. C. liquidity risk. D. basis risk. E. prepayment risk.

E. prepayment risk.

Recently, the regular collateralized debt obligations (CDO) market has been surpassed by: A. credit swaps. B. credit options. C. credit-default swaps. D. total-return swaps. E. synthetic collateralized debt obligations.

E. synthetic collateralized debt obligations.