a question about loan securitization, emergency!!!! help!! Thanks so much!!!!
Unlike bonds1 bank loans are difcult to buy and sell (illiquidity). Commercial Banks need sometimes the exibility to sell some of the loans they hold before maturity. This can be done through securitization. The process is as follows. Bank B wants to get rid of a loan L it granted to rm F several years ago. 3 creates a company? called special purpose vehicle [SF'V which raises money by issuing several tranches of bonds and equity. With that money? the 513"!I buys the loan from bank B. Shareholders and bondholders of the SP'vr are therefore stakeholders in a company which holds one single asset, the loan [El L has a one year maturity and a face value of $ljj. The next interest payment is at maturity. There are three possible scenarii for the year to come The economy is normal or booming (probability 0.9): F will be able to repay L in one year and will pay a 5%- interest rate {on face value). The economy is in recession (probability 0.05}: F will be able to pay only 75% of L face value in one year and no interests. The economy is in depression [probability 0.05): F will be able to pay only 40% of L face value in one year and no interests. The sole purpose of the SEWr is to carry the loan L. 1|iWhen L reaches maturity and pays 0E, the proceeds are shared among stakeholders and the SPV is dissolved. To nance the purchase of LJ the SFV issues 5'30 Senior Secured Bonds with a face value of $IJUUU and a coupon of 4.5933-? 3'30 Junior Secured Bonds with a. face value of $131300 and a coupon of 16%, Equity. Junior and Senior bonds are issued at par value (price of one bond is $1,IIIU]I 1. (It! points} Compute the expected return and the volatility of senior bonds and junior honds. Hint: compute houlI much each category of hondholder obtains in each state of the economy, use this result to compute bonds returns in each state of the economy, use this result to compute eapecteal fetum and volatility. lGhech this article on how to calculate the etpected return and volatility of a single asset if you need a refresher https: f/unuw. inuestopeclia. cone?waththrough/corporale-finance/Al/retu'm-rish/ empected-retum. aspm 2. (It! points} The market value of L is $950,0UU. Compute the expected return and volatility of L. Compare with Senior Bonds. Given that certain categories of institu tional investors are restricted from buying highrisk deht [say with volatility higher than with}, why is securitization useful? 3. [ll] points} Suppose that 3., instead of selling one large loan L to the 3131"."1 sells man}; dierent small loans with a total face value of $1 million. Each of those loans hears a 6% interest, has a oneyear maturit}r and the same volatility as L. Would you expect the Vltilit'}? of senior seourecl bonds to change {no Ioornputation]?I
