[ 2009 FRM Sample Exam ] Operational and Integrated risk management Q1 management, following, principal, reserve, amount

Abey

 

1. Which of the following is not a common type of credit enhancement utilized in a securitization?

A. Cash reserves

B. Issuance of tranches with a total principal amount that exceeds the total principal amount of the collateral

C. Diversion of excess spread to a reserve account

D. Subordination

Abey

 

Correct answer is B

(A) Cash contributed to a reserve to back cash flows on the liabilities in a securitization is a common form of credit enhancement.

(B) The opposite is true. Over-collateralization is a popular form of credit enhancement in which fewer liabilities are issued than assets. So, this is false.

(C) The credit quality of the senior liabilities issued in a securitization is often enhanced by diverting the excess income on assets over interest due on liabilities into a reserve account. That account is pledged to cover senior interest payments and is released to subordinated interest holders only after the senior obligations have been serviced.

(D) Subordination acts in the same way as excess of loss credit insurance and is perhaps the most common form of credit enhancement for the senior tranches in a securitization.