CFA LEVEL 1 - Fixed Income - Asset
Backed Securities
Securitization - answer The process of transferring ownership of assets such as loans
or receivables from the original owners into a special legal entity.
The special legal entity then issues securities, using cash flows to pay interest and
repay the principal to investors.
Asset-Backed Securities - answer Securities issued by a special legal entity.
Securitized Assets - answer The pool of assets from which asset-backed securities
cash flows are generated.
Mortgage-Backed Securities - answer Asset-backed securities backed by a pool of
mortgages, and a distinction is sometimes made between MBS and ABS backed by
non-mortgage assets.
Covered Bonds - answer Similar to ABS, but they differ because of their dual recourse
nature, strict eligibility criteria, dynamic cover pool, and redemption regimes in the event
of sponsor default.
Offer investors recourse to both the issuing financial institution and an underlying asset
pool.
Usually carry lower credit risks and offer lower yields than otherwise ABS.
Special Purpose Entity - answerSometimes called a special purpose vehicle (SPV) or a
special purpose company.
In almost all cases, is the ultimate owner of the loans, is legally independent, and is
considered bankruptcy remote from the seller of the loans.
Depositor - answerThe seller of the collateral
Collateral - answerThe pool of securitized assets from which the cash flows will be
generated. It is the debt obligations that have been securitized.
Benefits of Securitization - answer- Allows investors direct access to liquid investments
and payment streams that would be unattainable if all financing were performed through
banks.
, - It enables backs to increase loan originations at economic scales greater than if they
used only their in-house loan portfolios.
- Securitization contributes to lower costs of borrowing for entities raising funds, higher
risk-adjusted returns to investors, and greater efficiency and profitability for the banking
sector.
The Parties to a Securitization - answerInclude the seller of the collateral (pool of loans),
the servicer of the loans, and the special purpose entity (SPE).
The SPE is bankruptcy remote, which plays a pivotal role in securitization.
Subordination - answerA common structure in a securitization, which leads to the
creation of more than one bond class or tranche.
Bond classes differ as to how they will share any losses resulting from defaults of the
borrowers whose loans are in the collateral.
Motivation for the Creation of Different Types of Structures - answerTo redistribute
prepayment risk and credit risk efficiently among different bond classes in the
securitization.
Prepayment Risk - answerThe uncertainty that the actual cash flows will be different
from the scheduled cash flows as set forth in the loan agreements because borrowers
may choose to repay the principal early to take advantage of interest rate movements.
Mortgage - answerA loan secured by the collateral of some specified real estate
property that obliges the borrow to make a predetermined series of payments to the
lender.
Cash flows includes (1) interest, (2) scheduled principal payments, and (3) prepayments
(any principal repaid in excess of the schedules principal payment)
Mortgage Designs specify - answer(1) maturity of the loan;
(2) how the interest rate is determined (i.e. fixed rate versus adjustable or variable rate);
(3) how the principal is repaid (i.e. whether the loan is amortizing and if it is, whether it is
fully amortizing or partially amortizing with a balloon payment);
(4) whether the borrower has the option to prepay and if so, whether any prepayment
penalties might be imposed;
(5) the rights of the lender in a foreclosure (i.e., whether the loan is a recourse or non-
recourse loan)
Three Sectors for Securities Backed by Residential Mortgages - answer(1) those
guaranteed by a federal agency (Ginnie Mae) whose securities are backed by the full
faith and full credit of the US government.
(2) those guaranteed by a GSE (e.g. Fannie Mae and Freddie Mac) but not by the US
government.
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