READING 63 FIXED-INCOME SECURITIZATIONS Flashcards
(34 cards)
Which of the following best describes the role of the originator in the securitization process?
A. The entity that issues asset-backed securities to investors
B. The bank or corporation that creates the initial pool of loans or receivables
C. The special purpose entity that purchases loans and sells securities to investors
Correct Answer: B
Explanation:
The originator is the bank or corporation that originates (creates) the loans or credit assets that form the collateral pool.
Option A is incorrect because the issuer of the ABS is typically the SPE, not the originator.
Option C is incorrect as this describes the SPE, not the originator.
In securitization, the special purpose entity (SPE) primarily functions to:
A. Originate loans and extend credit to customers
B. Purchase collateral from the originator and issue asset-backed securities to investors
C. Manage regulatory capital reserves for the originator
Correct Answer: B
Explanation:
The SPE buys the collateral (loans) from the originator and issues ABS to investors.
Option A is incorrect because loan origination is the role of the originator.
Option C is incorrect since capital reserves are managed by the originator bank.
Which of the following is a benefit of securitization to the originating bank?
A. Increasing regulatory capital requirements
B. Improving liquidity by selling illiquid loan portfolios
C. Increasing credit risk exposure on the bank’s balance sheet
Correct Answer: B
Explanation:
Securitization improves liquidity by converting illiquid loans into cash.
Option A is incorrect as securitization typically lowers capital requirements.
Option C is incorrect because selling loans transfers credit risk away from the bank.
How does securitization increase a bank’s lending capacity?
A. By forcing the bank to raise additional deposits before lending more
B. By enabling the bank to receive cash proceeds from loan sales, which can be used to make new loans
C. By increasing the bank’s leverage on its balance sheet
Correct Answer: B
Explanation:
Securitization allows banks to recycle capital from loan sales and issue new loans without waiting to raise deposits.
Option A is incorrect because securitization reduces dependency on deposits.
Option C is incorrect since securitization typically reduces balance sheet leverage.
Which of the following best explains why ABSs offer tailored risk and return to investors?
A. Investors can select securities with varying maturities and risk profiles based on their preferences
B. ABSs guarantee fixed returns regardless of underlying loan performance
C. All ABSs carry the same credit risk as the originator’s other liabilities
Correct Answer: A
Explanation:
ABS structures can be customized into tranches with different risk/return profiles.
Option B is incorrect as ABS returns depend on loan performance and cash flow variability.
Option C is incorrect because ABS risk depends on the collateral, not the originator’s overall liabilities.
One advantage to investors of purchasing ABS instead of the underlying loans is:
A. The ability to directly service the loans and control borrower defaults
B. Greater liquidity allowing them to sell the securities more easily
C. Guaranteed principal repayment regardless of loan performance
Correct Answer: B
Explanation:
ABS are traded securities, making them more liquid than the underlying loans.
Option A is incorrect since investors do not service the loans.
Option C is incorrect as repayment depends on borrower performance.
What does it mean when the curriculum states that securitization “removes the originating bank from the intermediation process”?
A. The bank no longer acts as an intermediary between borrowers and investors after selling loans
B. The bank stops issuing loans altogether
C. The bank guarantees the payment to ABS investors
Correct Answer: A
Explanation:
Once loans are sold to the SPE, the bank is no longer involved in collecting payments or credit risk.
Option B is incorrect because banks continue issuing loans.
Option C is incorrect since the SPE carries the credit risk, not the bank.
Which statement correctly explains the difference in the term “issuer” as used in the Level I curriculum?
A. “Issuer” always refers to the SPE that issues ABSs
B. “Issuer” refers to the originator when discussing advantages of securitization and to the SPE when referring to legal issuance
C. “Issuer” exclusively refers to the originating bank or corporation
Correct Answer: B
Explanation:
The term “issuer” can mean the originator when discussing benefits and the SPE when discussing the actual securities issuance.
Options A and C are incorrect because the meaning depends on context.
How does securitization typically affect a bank’s capital reserve requirements?
A. It increases capital reserve requirements by adding more risk to the balance sheet
B. It lowers capital reserve requirements by removing credit risk from the bank’s balance sheet
C. It has no impact on capital reserves
Correct Answer: B
Explanation:
Selling loans removes risk and lowers regulatory capital requirements.
Option A is incorrect because risk is transferred away from the bank.
Option C is incorrect since capital requirements change with risk exposure.
Why might an investor prefer to buy ABS instead of directly investing in the underlying loans?
A. ABS provide access to diversified pools of loans without needing loan management expertise
B. ABS have a fixed guaranteed return with no credit risk
C. ABS require investors to actively manage loan collections
Correct Answer: A
Explanation:
Investors gain diversified exposure without operational involvement.
Option B is false as returns are variable and depend on loan performance.
Option C is incorrect because loan servicing is handled by third parties.
Which of the following best describes the systemic risk concern related to ABS investments?
A. Cash flows from collateral are always predictable
B. Excessive buildup of credit risk in ABS can destabilize the financial system, as seen in the 2007–2009 crisis
C. ABS investments are fully insured by governments
Correct Answer: B
Explanation:
Systemic buildup of risk in ABS contributed to the global financial crisis.
Option A is incorrect as cash flows are uncertain.
Option C is false; ABS are not government-insured.
What is a key reason why securitization can lower financing costs for originators?
A. Investors perceive ABS as less risky than other debt instruments
B. Securitization provides access to cheaper sources of capital compared to issuing debt or equity directly
C. Originators must pay higher fees to intermediaries when securitizing loans
Correct Answer: B
Explanation:
Securitization often offers a lower-cost funding alternative.
Option A is incorrect as ABS risk varies.
Option C is incorrect because higher fees would increase costs.
Which statement best explains how securitization improves market efficiency?
A. By making illiquid loans less accessible to investors
B. By allowing investors to trade more liquid ABS, prices better reflect current investor views
C. By eliminating risk from loan portfolios
Correct Answer: B
Explanation:
Greater liquidity helps price discovery and market efficiency.
Option A is false as securitization increases access.
Option C is incorrect because securitization transfers but does not eliminate risk.
The cash flows to ABS investors can vary due to:
A. Fixed interest payments made by the SPE
B. Borrowers prepaying or defaulting on their loans at unexpected rates
C. Government guarantees that adjust payments regularly
Correct Answer: B
Explanation:
Loan prepayments and defaults cause variability in payments.
Option A is false since cash flows depend on loan performance.
Option C is incorrect as most ABS are not government guaranteed.
When a bank securitizes loans and sells them to an SPE, which of the following is TRUE?
A. The bank retains the credit risk of the loans on its balance sheet
B. The SPE legally owns the loans and issues securities backed by those loans
C. The bank continues to issue ABS to investors
Correct Answer: B
Explanation:
The SPE holds legal ownership and issues ABS.
Option A is false because credit risk is transferred.
Option C is false since ABS issuance is by the SPE.
Which of the following best describes the concept of “improved liquidity” as a benefit of securitization to banks?
A. Banks can hold illiquid loan portfolios indefinitely without risk
B. Banks convert illiquid loans into cash by selling them, improving their ability to manage funds
C. Banks issue new equity to finance illiquid loans
Correct Answer: B
Explanation:
Securitization converts loans to cash, enhancing liquidity.
Option A is incorrect because illiquid loans tie up capital.
Option C is unrelated to liquidity improvement through securitization.
Which of the following statements about ABS is correct?
A. ABS are equity securities that represent ownership in the underlying loans
B. ABS are debt securities backed by cash flows from a pool of loans or receivables
C. ABS guarantee full repayment regardless of borrower performance
Correct Answer: B
Explanation:
ABS represent debt claims backed by loan repayments.
Option A is incorrect since ABS are not equity.
Option C is incorrect because repayment depends on loan performance.
What is one reason why ABS investors might prefer securities over direct loan ownership?
A. ABS provide diversification by pooling many loans into a single investment
B. Investors must manage individual borrower credit risk themselves
C. ABS require no due diligence before purchase
Correct Answer: A
Explanation:
Pooling reduces individual loan risk and improves diversification.
Option B is false because servicing is outsourced.
Option C is incorrect since investors still analyze risk.
Which of the following statements about the role of the SPE in securitization is TRUE?
A. The SPE manages the loan origination process
B. The SPE isolates the assets legally and issues securities to investors
C. The SPE guarantees payment to investors
Correct Answer: B
Explanation:
The SPE holds the assets and issues ABS.
Option A is false as loan origination is done by the originator.
Option C is false since the SPE does not guarantee payments beyond collateral performance.
How does securitization affect the leverage of the originating bank?
A. It increases leverage by adding loans to the balance sheet
B. It reduces leverage by removing loans and associated debt from the balance sheet
C. It has no impact on leverage ratios
Correct Answer: B
Explanation:
Securitization removes loans from the bank’s balance sheet, lowering leverage.
Option A is incorrect because loans are sold off.
Option C is incorrect as leverage is affected by balance sheet changes.
Which of the following best describes the primary role of the originator in a securitization process?
A. To issue ABSs to investors
B. To collect loan payments and handle delinquencies
C. To create and sell a pool of financial assets
Correct Answer: C
Explanation:
The originator (e.g., Fred Motor Company) creates and sells a pool of financial assets such as loans — it is often referred to as the seller or depositor.
A is incorrect because issuing ABSs is the role of the SPE.
B is incorrect because that’s the role of the servicer, although in some cases (like Fred), the originator and servicer are the same entity.
In a securitization transaction, the special purpose entity (SPE) is also known as the:
A. Trustee
B. Servicer
C. Issuer
Correct Answer: C
Explanation:
The SPE is commonly called the issuer, as it issues ABSs to investors.
A is incorrect because the trustee oversees and protects investor interests.
B is incorrect because the servicer collects payments and handles administrative tasks.
Which of the following best describes the servicer in a securitization?
A. A party that provides capital to the originator
B. A party responsible for issuing ABSs
C. A party that manages loan repayments and collections
Correct Answer: C
Explanation:
The servicer (e.g., Fred) handles loan collections, sends notices, and may repossess assets.
A is incorrect; that’s the investor’s role.
B is incorrect; the issuer/SPE sells the ABSs.
A bankruptcy-remote SPE is designed to:
A. Protect ABS holders from the credit risk of the underlying assets
B. Ensure the originator can access the collateral in case of default
C. Isolate ABS investors from the financial distress of the originator
Correct Answer: C
Explanation:
Bankruptcy remoteness protects ABS investors if the originator becomes insolvent.
A is incorrect; ABS holders are still exposed to credit risk of the collateral, not the originator.
B is incorrect because the SPE, not the originator, owns the collateral.
