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4、Synthetic collateralized debt obligations:

A) directly invest in loans but not bonds.

B) directly invest in both loans and bonds.

C) directly invest in bonds but not loans.

D) do not directly invest in underlying loans and bonds.

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5、In the creation of collateralized obligations, a bank is likely to use a special purpose vehicle (SPV) by:

A) purchasing from the SPV the underlying asset pool backing a collateralized obligation.

B) having the SPV conduct an auction of mortgages and invest the proceeds in equity. 

C) transferring the underlying asset pool of the collateralized obligation to the SPV.

D) having the SPV conduct an auction of credit-quality mortgages and invest the proceeds in subprime loans.

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The correct answer is C

In the creation of collateralized obligations, a bank is likely to use a SPV by transferring the underlying asset pool of the collateralized obligation to the SPV. Once the assets that comprise the underlying pool are transferred to the SPV, they are legally owned by the SPV. Thus, if the bank experiences financial distress, the SPV is not directly affected. This legal relationship is known as bankruptcy remote.

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AIM 3: Describe the difference between a cash and synthetic CDO.

1、Which of the following statements regarding cash collateralized debt obligations (CDOs) is FALSE?

A) Balance sheet-driven are the majority of cash CDOs.

B) An arbitrage CDO is issued to profit on the spread between the return on the underlying assets and the return paid to investors.

C) Cash CDOs have three phases in their lifetime. 

D) During the reinvestment phase, cash flows from prepayments and default recoveries are reinvested.

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The correct answer is A

Arbitrage CDOs are the majority of cash CDOs and are issued to profit on the spread between the return on the underlying assets and the return paid to investors. A bank or insurance company wishing to reduce their loan exposure on the balance sheet creates a balance sheet CDO. Cash CDOs have three phases in their lifetime. During the ramp up phase, the portfolio is created using financing from different tranches. During the reinvestment phase, cash flows from prepayments and default recoveries are reinvested, assuming coverage tests are satisfied. In the pay down phase, principal payments are made to junior and senior tranche holders and the CDO is wound down.

aianjie

 

The correct answer is D

SPVs are legally separate from the parent and thus are not exposed to the parent’s credit risk. They are usually AAA rated. They use balance sheet CDOs when they already own the asset and wish to transfer its risk and raise capital. A CDO of this type avoids notifying the debtor that the SPV has unloaded its debt, which can sometimes harm the relationship with the debtor. The SPV usually uses active management to earn high returns for the CDO.

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3、With respect to the assets underlying a collateralized debt obligation (CDO), the assets:

A) must be actively managed and cannot be held static.

B) must be held static for at least a year before they can be actively managed.

C) cannot be held static for more than a year and must be actively managed. 

D) can either be actively managed or held static.

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The correct answer is D

The assets can either be managed or held static.

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4、A collateralized debt obligation (CDO) pays out in tranches where each tranche has a specific level of credit protection. Which of the following lists tranches from highest priority of payment to lowest priority of payment?

A) Mezzanine tranche, equity tranche, senior tranche.

B) Collateralized tranche, equity tranche, mezzanine tranche.

C) Equity tranche, collateralized tranche, mezzanine tranche.

D) Senior tranche, mezzanine tranche, equity tranche.

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The correct answer is D

As its name implies, the senior tranche has the highest priority of payment. Mezzanine is next, and equity gets paid only after the other tranches have been paid.