Asset Backed Securities a) A financial corporation with a BBB rating has a consu
ID: 2753335 • Letter: A
Question
Asset Backed Securities
a) A financial corporation with a BBB rating has a consumer loan portfolio. An investment banker suggested that this corporation consider issuing an ABS where the collateral for the security is the consumer loan portfolio. What would be the advantage of issuing an ABS rather than a straight offering of corporate bonds?
b) A corporation is considering a securitization and is considering two possible credit enhancement structures, backed by a pool of auto-loans.
Principal Value
Structure I
Structure II
Pool of automobile loans
$304M
$301M
Senior class
$250M
$270M
Subordinate class
$50M
$30
Which structure would receive higher credit rating for the senior class and why? Which forms of credit enhancement are being used in both structures?
c) Explain how asset-backed securities, mortgage-backed securities, and securitization in general provide investors with the functions of financial institutions which are 1) maturity intermediation 2) reducing risk via diversification and 3) reduction of the costs of contracting and information processing. (That is securitization results in financial disintermediation)
Principal Value
Structure I
Structure II
Pool of automobile loans
$304M
$301M
Senior class
$250M
$270M
Subordinate class
$50M
$30
Explanation / Answer
The advantages of asset backed securities to corporate bonds is:
The coporation could raise money through bonds easier as the securities are issued by a SPV, aseperate company backed up with assets
Credit risk is less as the securities are backed up with assets as collateral
2.
Pool of automobile would receive higher credit rating as credit risk is lesser.
Credit risk would be higher in sub-ordinate class.
3.
The entire ddebt is divided into tranches:
First tranch has higher prepayment risk but less credit risk
Second tranch would have intermediate level of prepayment and credit risk
Last tranch would have higher credit risk.