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Questions and Answers of
Corporate Finance
What types of prepayment protection provisions result in a prepayment premium being paid if a borrower prepays?
The following statement was made in a special report, “Commercial Mortgage Special Report” (September 19, 2005, p. 2), by FitchRatings: “Defeasance of a loan in a CMBS transaction is a positive
In an article by Matt Hudgines “More CMBS Borrowers Pay off Balloon Mortgages on Time,” posted on August 18, 2010, the following appeared“Some 49.9% of the securitized loans that matured in
Answer the below questions.a. Explain whether you agree or disagree with the following statement: “The largest sector of the CMBS market is securities issued by agency and government-sponsored
Why do CMBS trade in the market more like corporate bonds than RMBS?
What are the major differences in structuring CMBS and RMBS transactions?
Why is the entity seeking to raise funds through a securitization referred to as the “seller” or the “originator”?
What is the limitation of a third-party guarantee as a form of credit enhancement?
An asset-backed security has been credit enhanced with a letter of credit from a bank with a single A credit rating. If this is the only form of credit enhancement, explain whether this issue can be
A corporation is considering a securitization and is considering two possible credit enhancement structures backed by a pool of automobile loans. Total principal value underlying the asset-backed
Answer the below questions.(a) What is meant by concentration risk?(b) How do rating agencies seek to limit the exposure of a pool of loans to concentration risk?
What is the difference between pool-level and loan-level analysis?
How do optional call provisions in a securitization differ from that of a call provision in a standard corporate bond?
What factors do the rating agencies consider in analyzing the structural risk in a securitization?
Why would an interest rate derivative be using in a securitization structure?
The below questions relate to auto loan-backed securities. Answer each one. (a) What is the cash flow for an auto loan-backed security?(b) Why are prepayments of minor importance for automobile
The following questions relate to credit card receivable-backed securities. Answer each one.(a) What happens to the principal repaid by borrowers in a credit card receivable-backed security during
In achieving the benefits associated with a securitization, why is the special purpose vehicle important to the transaction?
The below questions relate to rate reduction bonds. Answer each one. (a) What asset is the collateral?(b) What is a true up provision in a securitization creating rate reduction bonds?
What does the Dodd-Frank Wall Street Reform and Consumer Protection Act specify regarding a securitizer retaining credit risk in a securitization transaction?
How does a CDO differ from an ABS transaction?
Answer the below questions.a. If there is a shortfall in interest paid to the senior tranches of a CDO, how is the shortfall made up?b. If coverage tests are failed for a CDO, how is the principal
In a securitization, what is the difference between a servicer and a special purpose vehicle?
Answer the below questions.a. What is the difference between a one-step securitization and a two-step securitization?b. What is meant by the “depositor” in a securitization?
What is meant by a cash flow waterfall?
Explain the difference in the treatment of principal received for a self-liquidating trust and a revolving trust.
Answer the below questions.(a) In a securitization, what is a revolving period?(b) In a securitization, what is an early amortization provision?
Answer the below questions.(a) Why is credit enhancement required in a securitization?(b) What entity determines the amount of securities needed in a securitization?
Why is the MPR for credit card receivable-backed securities important?
What are the advantages of pooled investment vehicles relative to the direct purchase of fixed-income assets?
“The stock price of a passively managed ETF will also sell in the marketplace within 1% of its NAV.” Explainwhy you agree or disagree with this statement.
Why is it difficult for the stock price to follow theNAV of an active ETF?
What are the two major types of strategiesfollowedby hedge bond funds?
Some hedge funds refer to their strategies as “riskarbitrage strategies.” What does that mean?
How does the management fee structure of ahedge fund differ from that of an asset manager of a mutual fund?
What is the tax advantage for a company thatqualifies as a REIT?
Two investors are arguing about the types of investment made by real estate investment trusts. One investor believes that REITs are investors inreal estate properties. The other investor believes
What are the two types of mortgage REITs?
An open-end investment company has $510 million of assets, $10 million of liabilities, and 50 million shares outstanding.Answer the below questions.(a) What is its NAV?(b) Suppose the fund pays off
“An open-end fund’s NAV is determined continuously throughout the trading day.” Explain why you agree or disagree with this statement.
Why might the price of a share of a closed-end fund diverge from its NAV?
Why do mutual funds have different classes of shares?
What costs are incurred by an investor when purchasing a mutual fund?
What are the design flaws of a mutual fund?
What are the advantages of an exchange-traded fund relative to open-end and closed-end investment companies?
What is the role played by an ETF’s authorized participants?
What is meant by an interest-rate model?
Explain why in practice arbitrage-free models are typically used rather than equilibrium models.
Answer the below questions.(a) What is the empirical evidence on the relationship between volatility and the level of interest rates?(b) Explain whether the historical evidence supports the use of a
Comment on the following statement: “If an interest-rate model allows the possibility of negative interest rates, then it is not useful in practice.”
Answer the below questions.(a) What is meant by historical volatility?(b) What is meant by implied volatility?
Suppose that the following weekly interest rate volatility estimates are computed as: absolute rate change = 3.85 basis points and percentage rate change = 2.14%.Answer the below questions. (a) What
Answer the below questions. (a) Explain the drift property found in an interest-rate model.(b) Explain the volatility property found in an interest-rate model.(c) Explain the mean reversion property
What is the commonly used mathematical tool for describing the movement of interest rates that can incorporate the properties of an interest-rate model?
Answer the below questions.(a) Why is the most common interest-rate model used to describe the behavior of interest rates a one-factor model?(b) What is the one-factor in a one-factor interest-rate
Answer the below questions. (a) What is meant by a normal model of interest rates?(b) What is meant by a lognormal model of interest rates?
Answer the below questions.a. Explain the treatment of the dynamics of the volatility term for the Vasicek interest rate model.b. Explain the treatment of the dynamics of the volatility term for the
What is an arbitrage-free interest-rate model?
Answer the below questions.(a) What are the general characteristics of the Ho-Lee arbitrage-free interest-rate model?(b) How does the Ho-Lee arbitrage-free interest-rate model differ from the
What is an equilibrium interest-rate model?
What are the two drawbacks of the traditional approach to the valuation of bonds with embedded options?
Explain why you agree or disagree with the following statement: “An investor should be unwilling to pay more than the call price for a bond that is likely to be called.”
In Robert Litterman, Jose Scheinkman, and Laurence Weiss, “Volatility and the Yield Curve,”Journal of Fixed Income, (Premier Issue, 1991), p. 49, the following statement was made: “Many fixed
If an on-the-run issue for an issuer is evaluated properly using a binomial model, how would the theoretical value compare to the actual market price?
The current on-the-run yields for the Ramsey Corporation are as follows:Assume that each bond is an annual-pay bond. Each bond is trading at par, so its coupon rate is equal to its yield to
Explain how an increase in expected interest-rate volatility can decrease the value of a callable bond.
Answer the below questions.(a) What is meant by the option-adjusted spread?(b) What is the option-adjusted spread relative to?
“The option-adjusted spread measures the yield spread over the Treasury on-the-run yield curve.” Explain why you agree or disagree with this statement.
The following excerpt is taken from an article titled “Call Provisions Drop Off” that appeared in the January 27, 1992, issue of BondWeek, p. 2: “Issuance of callable long-term bonds dropped
The following excerpt is taken from an article titled “Eagle Eyes High-Coupon Callable Corporates” that appeared in the January 20, 1992, issue of BondWeek, p. 7: “If the bond market rallies
What is the static spread for a three-year 9% coupon corporate bond selling at 105.58, given the following theoretical Treasury spot rate values equal to 50, 100, or 120 basis
Under what conditions would the traditional yield spread be close to the static spread?
Why is the investor of a callable bond exposed to reinvestment risk?
What is negative convexity?
Does a callable bond exhibit negative or positive convexity?
Suppose that you are given the following information about two callable bonds that can be called immediately:You are told that both of these bonds have the same maturity and that the coupon rate of
The theoretical value of a noncallable bond is $103; the theoretical value of a callable bond is $101. Determine the theoretical value of the call option.
Explain why you agree or disagree with the following statement: “The value of a putable bond is never greater than the value of an otherwise comparable option-free bond.”
Suppose you are told that the cash flow yield of a pass-through security is 9% and that you are seeking to invest in a security with a yield greater than 8.8%.Answer the below questions.(a) What
Explain how, given the cash flow on the simulated interest-rate paths, the theoretical value of a RMBS is determined.
Explain how, given the cash flow on the simulated interest-rate paths, the average life of a RMBS is determined.
Suppose that a support bond is being analyzed using the Monte Carlo simulation methodology. The theoretical value using 1,500 interest-rate paths is 88. The range for the path present values is a
In a well-protected PAC structure, what would you expect the distribution of the path present values and average lives to be compared to a support bond from the same CMO structure?
Suppose that the following values for a RMBS are correct for each assumption:PSA AssumptionValue of Security192112.10194111.80200111.20202111.05210110.70Assuming that the value of the security in the
An analysis of a CMO structure using the Monte Carlo method indicated the following, assuming 12% volatility:(a) Calculate the option cost for each tranche.(b) Which tranche is clearly too rich?(c)
Why would the option-adjusted spread vary across dealer firms?
Explain how the number of interest-rate paths used in the Monte Carlo simulation methodology is determined.
Explain why you agree or disagree with the following statement: “When the Monte Carlo simulation methodology is used to value a RMBS, a PSA assumption is employed for all interest-rate paths.”
Answer the below questions.(a) What assumption is made about the OAS in calculating the effective duration and effective convexity of a RMBS?(b) Is it warranted?
Using the cash flow yield methodology, a spread is calculated over a comparable Treasury security. How is a comparable Treasury determined?
What are the limitations of the option-adjusted spread measure?
What assumptions are required to assess the potential total return of a RMBS?
What are the complications of assessing the potential total return of a CMO tranched using the total return framework?
On July 1, 2013, the FHLMC 30-Year Generic 4% 2012 was analyzed using the Monte Carlo valuation model of FactSet. At the time of the analysis the security’s price was 104.644 with accrued interest
What is vector analysis?
In the calculation of effective duration and effective convexity, why is a prepayment model needed?
The following excerpt is taken from an article titled “Fidelity Eyes $250 Million Move into Premium PACs and I-Os” that appeared in the January 27, 1992, issue of BondWeek, pp. 1 and 21: “Three
In an article titled “CUNA Mutual Looks for Noncallable Corporates” that appeared in the November 4, 1991, issue of BondWeek, p. 6, Joe Goglia, a portfolio manager for CUNA Mutual Insurance
What is a path-dependent cash flow security?
Why is a pass-through security a path-dependent cash flow security?
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