[ 2009 FRM Sample Exam ] Quantitative Analysis Q11 department, following, because, private, balance

lalamei

 

11. A department store chain has a B1 rating from Moody's and a B+ rating from S&. Its balance sheet reflects a large number of receivables from shoppers who use the chain's private label credit card. The firm has decided to raise much needed funds for renovation via securitization of these receivables. Which of the following scenarios is the most likely outcome?

A. The bond issued in the securitization will be B1/B+ rated because the department store chain is so rated.

B. The asset-backed security (ABS) will be have a senior tranche that is rated investment-grade and whose face value is lower than the value of the receivables that were on the firm's balance sheet.

C. The asset-backed security (ABS) will be overcollateralized with the receivables that had been on the firm's balance sheet and are now a liability of the special purpose entity (SPE).

D. The securitization will result in a bond with two tranches; one which is senior and receives a Ba3/BB- rating, and another which is junior and receives a B2/B-.

lalamei

 

Correct answer is Bfficeffice" />

A large fraction of ABSs are structured with senior and sub tranches.  The senior is usually AAA because it has the full backing of all the assets in the pool that the SPE owns, while the sub tranche only gets paid back ifr the senior tranche is paid in full.  To ensure that the default risk is lower, the senior tranche is smaller than the pool of receivables backing the bond.