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2. BA-FM 24P(2018)-A (LEC) Banking and Financial Institution > Chapter 9: Derivatives, Loan Sales & Securitization > Flashcards

Chapter 9: Derivatives, Loan Sales & Securitization Flashcards

1
Q

are financial contracts whose value is derived from the performance of an underlying asset, index, or interest rate.

A

Derivative securities

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2
Q

use derivatives to secure prices and mitigate potential losses from adverse market movements.

A

Hedger

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3
Q

play a crucial role in managing a FI’s interest rate, foreign exchange, and credit risk exposures.

A

Derivatives

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4
Q

An agreement to transact involving the immediate exchange of assets and funds.

A

Spot Contract

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5
Q

An agreement to transact involving the future exchange of a set amount of assets at a set price.

A

Forward Contract

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6
Q

An agreement to transact involving the future exchange of a set amount of assets for a price that is settled daily.

A

Futures Contract

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7
Q

An investment that is made with the intention of reducing the risk of adverse price movement in asset.

A

Hedge

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8
Q

Describes the prices on outstanding futures contracts that are adjusted each day to reflect current futures market conditions.

A

Market to Market

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9
Q

Hedging the entire duration gap of an FI. An investment technique used to mitigate or eliminate downside systemic risk from a portfolio of assets.

A

Macrohedging

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10
Q

Using a derivative securities contract to hedge a specific asset or liability. An investment technique used to eliminate the risk of a single asset from a larger portfolio.

A

Microhedging

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11
Q

An option contract giving the holder the right to buy an underlying asset at a specified price within a specific time frame.

A

Put option

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12
Q

An option contract giving the holder the right to sell an underlying asset at a specified price within a specific time frame.

A

Call option

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13
Q

are financial contracts that give buyers the right, but not the obligation, to buy or sell an underlying asset at an agreed-upon price and date.

A

Options

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14
Q

Options hedged against ___________________.

A

interest rate risks

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15
Q

is an agreement that protects against rising interest rates. It sets a maximum interest rate, and if rates exceed this level, the seller compensates the buyer.

A

Caps

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16
Q

provides protection against falling interest rates by setting a minimum interest rate. If rates drop below this level, the seller compensates the buyer.

A

Floors

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17
Q

combines elements of both caps and floors. It involves simultaneous positions in a cap and a floor, providing a range of protection against both upward and downward interest rate movements.

A

Collars

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18
Q

is the risk that the counterparty defaults on payment obligations

A

Contingent Credit Risk

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19
Q

is an agreement between two parties to exchange financial instruments, cash flows, or payments for a specific period.

A

Swaps

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20
Q

It involves swapping the values or cash flows of one asset for another

A

Swaps

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21
Q

Five Generic Types of Swaps

A
  1. Interest Rate Swaps
  2. Currency Swaps
  3. Credit Risk Swaps
  4. Commodity Swaps
  5. Equity Swaps
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22
Q

is a financial derivative contract between two parties to exchange interest rate payments, with one party making fixed-rate payments and the other making floating-rate payments. This is done to manage or hedge against interest rate risk.

A

interest rate swap

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23
Q

involves the exchange of principal and interest payments in one currency for equivalent payments in another currency.

A

currency swap

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24
Q

It is often used to hedge against currency exchange rate risk or to obtain cheaper financing in a different currency.

A

currency swap

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25
Q

these swaps are contracts that allow an investor to “swap” or offset their credit risk with another party.

A

Credit Risk Swaps

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26
Q

True or False

If a borrower defaults on their debt, the CDS seller compensates the CDS buyer for the profit.

A

False

If a borrower defaults on their debt, the CDS seller compensates the CDS buyer for the loss.

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27
Q

are agreements between two parties to exchange payments based on the price of a specific commodity over a predetermined period.

A

Commodity swaps

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28
Q

involve the exchange of cash flows based on the returns of an equity index, a basket of individual stocks, or a single stock.

A

Equity Swaps

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29
Q

is a technique used to manage foreign exchange risk by mitigating the effects of currency fluctuations on international trade or investment.

A

Hedging with currency swaps

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30
Q

It is a widely used strategy to minimize the risk associated with fluctuating interest rates.

A

HEDGING WITH INTEREST RATE SWAPS

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31
Q

2 steps of HEDGING WITH INTEREST RATE SWAPS

A

Step 1: Identify the Interest Rate Risk Exposure

Step 2: Execute the Interest Rate Swap

32
Q

limits upside profits but not downside losses

A

writing options

33
Q

limits downside losses but not upside profits

A

buying options

34
Q

produce symmetric gains and losses

A

futures

35
Q

protect against losses but do not fully reduce gains

A

options

36
Q

are OTC contracts, unlike options and futures

A

swaps and forwards

37
Q

are marked to market daily

A

futures

38
Q

can be written for longer time horizons

A

swaps

39
Q

the packaging and selling of loans and other assets backed by loans issued by the FI

A

Loan sales and securitization

40
Q

are mechanisms that FIs have used to hedge their credit risk, interest rate risk, and liquidity risk exposures.

A

loan sales and securitization

41
Q

In addition, _______________________ have allowed FI asset portfolios to become more liquid.

A

loan sales and securitization

42
Q

Is An Event Where The Borrower Sells The Debt They Owe To Another Party, Reducing Their Own Debt While Transferring The Responsibility Of Repayment To The Purchasing Entity.

A

Loan Sale

43
Q
  • market makers generally large commercial banks (CBs) and investment banks (IBs)
  • active traders mainly IBs, CBs, and vulture funds

-occasional sellers and investors

A

LOAN MARKET PARTICIPANTS

44
Q

TYPES OF LOAN SALES CONTRACTS

A
  1. Participations
  2. Assignments
45
Q

represent the bulk of loan sales.

A

assignments

46
Q

THE LOAN SALES MARKET

A
  1. Traditional Short-Term Segment
  2. HLT Loan Sales
  3. LDC Loans
47
Q

Distressed loans

A
  1. Investment Banks
  2. Vulture funds
48
Q

Non -distressed loans

A
  1. Investment Banks
  2. Vulture funds
  3. Other Domestic Banks
  4. Foreign Banks
  5. Insurance Companies and Pension Funds
  6. Close-end bank loan mutual funds
  7. Nonfinancial Corporations
49
Q

LOAN SELLERS

A
  1. Money center banks
  2. Small regional or community banks
  3. Foreign Banks
  4. Investment banks
  5. Hedge Funds
  6. The U.S. Government and Its Agencies
50
Q

has emerged since the mid-1980s. Large banks in New York and London trade these debts, and the trading volume has increased a lot

A

Secondary Market for Less Developed Country Debt

51
Q

FACTORS ENCOURAGING FUTURE LOAN SALES GROWTH

A
  1. Fee income
  2. Liquidity Risk
  3. Capital Cost
  4. Reserve requirements
52
Q

refers to the revenue that banks and financial institutions earn from various fees charged to borrowers or other parties in relation to loan services.

a. Reserve requirements
b. Fee income
c. Liquidity risk
d. Capital Cost

A

b. Fee income

53
Q

properly managing __________ allows the bank to maintain a stable balance of liquid assets and loans

a. Reserve requirements
b. Fee income
c. Liquidity risk
d. Capital Cost

A

c. Liquidity risk

54
Q

lowering ____________ optimizes the bank’s capital allocation, allowing for more competitive loan rates.

a. Reserve requirements
b. Fee income
c. Liquidity risk
d. Capital Cost

A

d. Capital Cost

55
Q

meeting ________________ ensures the bank has sufficient funds to cover withdrawals and adhere to regulations.

a. Reserve requirements
b. Fee income
c. Liquidity risk
d. Capital Cost

A

a. Reserve requirements

56
Q

FACTORS DISCOURAGING FUTURE LOANS SALES GROWTH

A
  1. Access to commercial paper (CP) market
  2. Legal Concerns
57
Q

banks may rely more on commercial papers for funding, which could reduce their focus on originating new loans.

a.Legal Concerns
b. Access to commercial paper (CP) market

A

b. Access to commercial paper (CP) market

58
Q

fraudulent conveyance

a. Legal Concerns
b. Access to commercial paper (CP) market

A

Legal Concerns

59
Q

is the packaging of loans or other assets into newly created securities and selling these asset-backed securities (ABS) to investors

A

Loan securitization

60
Q

There are three major forms of securitization:

A
  1. Pass-through securities
  2. Collateralized mortgage obligations
  3. Mortgage-backed bonds
61
Q

promised payments by households of principal and interest on pools of mortgages created by financial institutions to secondary market investors (mortgage-backed security bond holders) holding an interest in these pools.

A

Pass-through mortgage securities

62
Q

Each pass-through mortgage security represents a ____________________ in a mortgage pool.

A

fractional ownership share

63
Q

Mortgage loan securitization reduces (or removes) the regulatory tax burden, interest rate risk exposure, and liquidity risk exposure that FIs face when they issue mortgages. It does, however, introduce a new risk called _______________ to the pass-through security holder.

A

prepayment risk

64
Q

is the risk involved with the premature return of principal on a fixed-income security. When debtors return part of the principal early, they do not have to make interest payments on that part of the principal. That means investors in associated fixed-income securities will not receive interest paid on the principal.

A

Prepayment risk

65
Q

is a multiclass pass-through with a number of different bond holder classes or tranches differentiated by the order in which each class is paid off.

A

Collateralized mortgage obligations (CMOs)

66
Q

can be created either by packaging and securitizing whole mortgage loans or, more frequently, by placing existing pass-throughs in a trust off the balance sheet.

A

Collateralized mortgage obligations (CMOs)

67
Q

The trust issues these CMOs in three classes:

A
  1. Class A
  2. Class B
  3. Class C
68
Q

are paid first with repayments and prepayments until the time their payments are fully done.

CMO holders have the least prepayment protection

a. Class A
b. Class B
c. Class C

A

a.Class A

69
Q

receives principal prepayment cash flows after class A.

a. Class A
b. Class B
c. Class C

A

b. Class B

70
Q

the last trance to principal payments.

holders have the most. So, __________ investors are subject to the least amount of risk compared to the rest.

a. Class A
b. Class B
c. Class C

A

c. Class C

71
Q

One drawback of CMOs is that originators may not be able to pass through all interest payments on a tax-free basis when they issue multiple debt securities. This creates a tax problem for various originators. This led to the creation of a new type of mortgage-backed security called a _________________

A

REMIC (real estate mortgage investment conduit).

72
Q

are bonds collateralized by a pool of assets.

A

Mortgages-back bonds

73
Q

produces a constant cash flow within a band of prepayment rates

A

planned amortization class (PAC).

74
Q

offers greater predictability of cash flows

A

planned amortization class (PAC)

75
Q

have priority over all other classes in receiving principal payments

A

planned amortization class (PAC)

2. BA-FM 24P(2018)-A (LEC) Banking and Financial Institution (9 decks)

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