AIM 1: Define securitization and describe the process and the role the participants play.

1、Which of the following scenarios has the most favorable effect on an originator’s financial condition?

A) A true sale of all assets where proceeds are used to issue new securities.

B) A sale with subordinated tranche retention used to pay off existing debt.

C) A true sale of all assets where proceeds are used to pay off existing debt.

D) A sale with subordinated tranche retention used to purchase Treasury securities.

The correct answer is C

If an originator retains a subordinated tranche, they are subject to the first of any losses, which may not improve their financial condition. From an investor’s perspective, the best use of asset sale proceeds is the repayment of existing debt.

2、Securitization can transform ________, credit ___________ assets into _________, credit _________ assets.

A) illiquid, insensitive, liquid, sensitive.

B) liquid, insensitive, illiquid, sensitive.

C) illiquid, sensitive, liquid, insensitive.

D) liquid, sensitive, illiquid, insensitive. 

The correct answer is C

Securitization is the process of pooling illiquid credit sensitive assets and repackaging into more liquid and less sensitive securities.

3、Which of the following are possible assets for securitization?

      I. Aircraft leases.

     II. Tobacco legal settlements.

    III. Equipment used for making glass bottles.

    IV. Trade receivables.

A) I only.

B) II and III.

C) III and IV.

D) I, II, and IV.

The correct answer is D

Any asset that either generates or has the potential to generate cash flows is a possible candidate for securitization. Aircraft leases and trade accounts receivables both generate cash flows, while tobacco legal settlements have the potential to. Equipment by itself does not directly generate cash flows; however, note that a lease on such equipment would be a candidate for securitization.

4、Which of the following are often cited as motivations for originators to participate in the securitization marketplace?

      I. Cash is readily accessible.

     II. The amount of required regulatory capital decreases.

    III. Liability risk can be swapped for asset risk.

    IV. Assets and liabilities are better matched.

A) I only.

B) I, II, and IV.

C) I and III.

D) II and IV.

The correct answer is B

One of the motivations for participating in the securitization marketplace has been the ability to reduce credit risk, not swap one risk for another.

5、Securitization of trade receivables transfers which risk(s)?

A) Market risk. 

B) Credit and market risk. 

C) Credit risk. 

D) Credit, market, and operational risk. 

The correct answer is C

By monetizing the asset, the originator has transferred the credit risk to the SPE.

6、The key to whether a separate relationship exists between loan originators and special purpose entities (SPEs) in a securitization is whether:

A) a “separate corporation” of the entities has occurred.

B) a “complete sever” of the relationship between the entities has occurred.

C) an “approved sale” of the assets has occurred.

D) a “true sale” of the assets has occurred.

The correct answer is D

The assets have to transfer from the loan originators to the SPEs through a "true sale" for a securitization to have transferred real ownership of the assets.

7、Typical participants in a securitization include:

I.           underwriter, sponsor, regulatory agency.

II.         transferee, structuring agent, originator.

III.        sponsor, law firm, trustee.

A) I and II only.

B) I and III only.

C) II and III only.

D) I, II, and III only.

The correct answer is C

All of the participants are typically included in a securitization except the regulatory body. The regulator will be involved if the circumstances of the deal warrant oversight.

8、Which of the following statements most accurately describes the effect of selling a loan without recourse? The:

A) bank that sells the loan retains a contingent liability.

B) loan is removed from the balance sheet of the bank that sells the loan.

C) bank that sells the loan bears a specified percentage of the credit risk.

D) purchaser has the right to sell the loan back to the bank that originated the loan.

The correct answer is B

When a bank originates a loan and then sells it without recourse, the loan is removed from the bank's balance sheet, and the purchaser bears all of the credit risk.

AIM 2: Analyze the differences in the mechanics of issuing securitized products using a trust or special purpose entity.

Why might the trust structure utilize a master trust and guarantor trust? 

    I. The assets can be considered a true sale.

    II. Generate additional trustee fees.

    III. The trust remains bankruptcy remote.

A) I and II. 

B) I and III. 

C) III only. 

D) I only. 

The correct answer is D

The two trust structure allows the assets conveyed to be sufficiently distanced from the originator. Thus, the assets are considered a true sale and the originator, not the trust, remains bankruptcy remote. The two trust structure may generate more fees but that is not the motivation for its use.

AIM 5: Discuss the various types of internal and external credit enhancements as well as liquidity support.

1、King Motors Acceptance Corporation (KMAC), the finance arm of King Motors, issues an auto-loan asset-backed security that consists of a senior tranche, denoted Tranche A in the amount of $50 million and an interest payment of 5 percent, and two subordinated tranches, denoted Tranches X and Z respectively, each with a face amount of $35 million. Tranche X pays investors annual interest at a rate of 6.5 percent while Tranche Z pays investors annual interest at a rate of 7.5 percent. Which of the following methods of credit support would NOT affect the credit quality of subordinated Tranche X?

A) The total amount of the auto loans that make up the asset-backed issue is $125 million.

B) The weighted average interest rate on the auto loans making up the pool is 6.4 percent.

C) KMAC has a reserve in the amount of $10 million that will remain on KMAC’s balance sheet. 

D) Any defaults on the part of King Motors customers will be first absorbed by Tranche Z. 

The correct answer is C

An investor’s claim when purchasing an ABS is solely with the ABS and no longer with the originator. The fact that KMAC has $10 million set aside means nothing for the ABS issue if it remains on KMAC’s balance sheet and is not part of the ABS issue. The other answer choices all describe forms of credit support that will support at least Tranches X and A, if not all 3 tranches. By having Tranche Z be subordinate to Tranche X, Tranche X has additional support. Also, loans of $125 million are used to back asset-backed securities worth ($50 + $35 + $35) = $120 million, which means the issue is overcollateralized. The weighted average interest rate paid on the securities is approximately 6.2%. If the weighted average interest rate on the loans that make up the pool is 6.4% that means there is an excess spread between the loans and securities that also provides support for the entire issue.

2、Which of the following is NOT an example of providing credit support in a securitization?

A) Creating subordinated tranches.

B) Eliminating first loss positions.

C) Generating excess spread.

D) Over collateralizing.

The correct answer is B

First loss positions provide credit support in a securitization. Eliminating first loss positions would remove credit support.

3、Which of the following statements about credit enhancement is FALSE?

A) Excess spread is a form of external credit enhancement. 

B) Cash collateral account is a form of internal credit enhancement. 

C) A credit default swap is a form of external credit enhancement. 

D) Overcollateralization is a form of internal credit enhancement. 

The correct answer is A

Excess spread is a form of internal credit enhancement where the differential cash flows between the SPE assets and liabilities is diverted to provide support against shortfalls.

4、There is difficulty in achieving risk transfer from securitized assets sold through all of the following EXCEPT:

A) first-loss retention. 

B) true sale.

C) overcollateralization.

D) credit enhancement.

The correct answer is B

The only time risk transfer can take place from loan originators to the investors is if there are no credit enhancements, such as over-collateralization or retention of first loss positions. Effective risk transfer can only occur in the situation of a true sale from the loan originator to the special purpose entity created to sell the assets as asset-backed securities.

5、Credit enhancement for asset-backed securities (ABSs) is typically achieved through all of the following EXCEPT:

A) overcollateralization.

B) creation of a subordinated tranche.

C) a call provision. 

D) an excess spread.

The correct answer is C

Credit enhancement for asset-backed securities (ABSs) is typically achieved through overcollateralization, an excess spread between payments promised and payments to be received, creation of a subordinated tranche to bear default risk, or provision of a third-party guarantee.

6、Which of the following is least likely an example of internal credit enhancement?

A) Bond insurance.

B) Cash reserve funds.

C) Excess servicing spread accounts.

D) Over-collateralization.

The correct answer is A

Bond insurance is an example of external, not internal, credit enhancement.

AIM 7: Discuss the securitization process for mortgage-backed securities and asset-backed commercial paper.

1、The typical asset-backed commercial paper (ABCP) securitization:

A) continually purchases assets and issues notes. 

B) trade in active secondary markets. 

C) faces minimal liquidity risk. 

D) involves single-sellers of receivables. 

The correct answer is A

ABCP trade in illiquid markets, involve multi-sellers and face significant liquidity risk.

2、Which of the following statements about mortgage-backed securities is FALSE?

A) MBS utilize minimal credit enhancement. 

B) MBS bear minimal credit risk. 

C) CMOs distribute prepayment risk evenly across different tranches. 

D) MBS face significant prepayment risk. 

The correct answer is C

CMOs distribute prepayment risk differentially across security holders.