LOS i, (Part 2): State the motivation for a corporation to issue an asset-backed security, and describe the types of external credit enhancements for asset-backed securities.

Q1. There are several types of external credit enhancements. All of the following are examples of external credit enhancements EXCEPT:

A)   letters of credit.

B)   setting aside reserve funds.

C)   corporate guarantees.

Q2. Which of the following statements concerning asset-backed securities (ABSs) is least accurate?

A)   ABSs typically have lower debt ratings than the firm's other borrowings.

B)   The asset-backed pool may be overcollateralized to provide a credit enhancement.

C)   Typical assets to securitize are auto loans and credit card receivables.

Q3. A corporation may issue asset backed securities because:

A)   it wants to change the structure of its balance sheet.

B)   both of the reasons are valid.

C)   it wants to reduce the cost of borrowing.

Q4. To reduce the cost of long-term borrowing, a corporation with a below average credit rating could:

A)   issue asset backed securities.

B)   decrease credit enhancement.

C)   issue commercial paper.

Q5. The issuance of asset backed securities (ABSs) versus straight debt would be desirable if:

A)   a better credit quality is desired on the asset backed versus the corporation.

B)   there are time constraints on the deal.

C)   the corporation's credit rating may go up in the future.

Q6. Which of the following terms describe external credit enhancements for asset backed securities?

A)   Corporate guarantee.

B)   Both of these choices are external credit enhancements.

C)   Bond insurance.

Q7. Which of the following is a general problem associated with external credit enhancements? External credit enhancements:

A)   are very long-term agreements and are therefore relatively expensive.

B)   are subject to the credit risk of the third-party guarantor.

C)   are only available on a short-term basis.

Q8. External credit enhancement least likely includes:

A)   corporate guarantee.

B)   revenue fund.

C)   bond insurance.

LOS i, (Part 2): State the motivation for a corporation to issue an asset-backed security, and describe the types of external credit enhancements for asset-backed securities.fficeffice" />

Q1. There are several types of external credit enhancements. All of the following are examples of external credit enhancements EXCEPT:

A)   letters of credit.

B)   setting aside reserve funds.

C)   corporate guarantees.

Correct answer is B)

Setting aside reserve funds is an example of internal, not external credit enhancement.

Q2. Which of the following statements concerning asset-backed securities (ABSs) is least accurate?

A)   ABSs typically have lower debt ratings than the firm's other borrowings.

B)   The asset-backed pool may be overcollateralized to provide a credit enhancement.

C)   Typical assets to securitize are auto loans and credit card receivables.

Correct answer is A)

The objective of the firm with an ABS issue typically is to get a higher debt rating (a lower cost of borrowing). Typically, the ABS has a higher debt rating, perhaps because of credit enhancements.

Q3. A corporation may issue asset backed securities because:

A)   it wants to change the structure of its balance sheet.

B)   both of the reasons are valid.

C)   it wants to reduce the cost of borrowing.

Correct answer is B)

Both of the reasons are valid.

Q4. To reduce the cost of long-term borrowing, a corporation with a below average credit rating could:

A)   issue asset backed securities.

B)   decrease credit enhancement.

C)   issue commercial paper.

Correct answer is A)

Commercial paper is a short-term promissory note. Decreasing credit enhancements increase the cost of borrowing.

Q5. The issuance of asset backed securities (ABSs) versus straight debt would be desirable if:

A)   a better credit quality is desired on the asset backed versus the corporation.

B)   there are time constraints on the deal.

C)   the corporation's credit rating may go up in the future.

Correct answer is A)

If there are time constraints, straight debt would be easier to issue. Also, if the corporation could be upgraded, it would benefit in straight debt but not its ABSs.

Q6. Which of the following terms describe external credit enhancements for asset backed securities?

A)   Corporate guarantee.

B)   Both of these choices are external credit enhancements.

C)   Bond insurance.

Correct answer is B)

Both of the choices are commonly used external credit enhancements.

Q7. Which of the following is a general problem associated with external credit enhancements? External credit enhancements:

A)   are very long-term agreements and are therefore relatively expensive.

B)   are subject to the credit risk of the third-party guarantor.

C)   are only available on a short-term basis.

Correct answer is B)

According to the “weak link” philosophy adopted by rating agencies, the credit quality of an issue can not be higher than the credit rating of the third-party guarantor. Along these lines, if the guarantor is downgraded, the issue itself could be subject to downgrade even if the structure is performing as expected.

Q8. External credit enhancement least likely includes:

A)   corporate guarantee.

B)   revenue fund.

C)   bond insurance.

Correct answer is B)

External enhancements include corporate guarantees and bond insurance. A revenue fund is not an external enhancement it is an internal enhancement.

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