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CHAPTER 9
RISK MANAGEMENT USING ASSET-BACKED SECURITIES, LOAN SALES, CREDIT STANDBYS, AND CREDIT DERIVATIV F. Collateralized Debt Obligations
G. Risks Associated With Credit Derivatives
VI. Summary of the Chapter
Concept Checks
9-1. What does securitization of assets mean?
Securitization involves the pooling of groups of earning assets, removing those pooled assets from the bank’s balance sheet, and issuing securities against the pool. As the pooled assets generate interest income and repayments of principal the cash generated by the pooled earning assets flows through to investors who purchased those securities.
9-2. What kinds of assets are most amenable to the securitization process?
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The best types of assets to pool are high quality, fairly uniform loans, such as home mortgages or credit card receivables.
9-3. What advantages does securitization offer lending institutions?
Securitization gives lending institutions the opportunity to use their assets as sources of funds and, in particular, to remove lower-yielding assets from the balance sheet to be replaced with higher-yielding assets.
9-4. What risks of securitization should the managers of lending institutions be aware of?
Lending institutions often have to use the highest-quality assets in the securitization process which means the remainder of the portfolio may become more risky, on average, increasing the bank’s capital requirements.
9-5. Suppose that a bank securitizes a package of its loans that bear a gross annual interest yield of 13 percent. The securities issued against the loan package promise interested investors an annualized yield of percent. The expected default rate on the packaged loans is percent. The bank agrees to pay an annual fee of to a security dealer to cover the cost of underwriting and advisory services and a fee of percent to Arunson Mortgage Servicing Corporation to process the expected payments generated by the pac