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LOS c: Distinguish between the payment structure and collateral structure of a securitization backed by amortizing assets and non-amortizing assets. fficeffice" />

Q1. Which of the following is NOT a feature of an asset-backed security backed by non-amortizing assets?

A)   The composition of the underlying loans does not change.

B)   During a lockout period, principal payments are not distributed to the bondholders.

C)   A call provision can be triggered when collateral reaches a certain level.

Correct answer is A)

In an asset-backed security backed by non-amortizing assets (e.g. credit cards), the composition of loans in the pool will change. During the lockout period, principal payments are not distributed to bondholders. Instead, new loans are purchased and this structure is referred to as a revolving structure. However, the retirement of principal (i.e. a call provision) in a revolving structure can be triggered by several different events. These events include a specific date, when the collateral falls below a certain level, or when cumulative losses in the collateral reach a certain level.

 

Q2. Which of the following statements regarding the structure of asset-backed securities (ABS) backed by amortizing assets is FALSE?

A)   An example of this ABS is that backed by automobile loans.

B)   A lockout period results in a revolving structure.

C)   No new loans are added to the pool.

Correct answer is B)

In an asset-backed security backed by amortizing assets (e.g. automobile loans), the composition of loans in the pool will not change. No new loans are purchased. A lockout period provision refers to an ABS backed by non-amortizing loans.

 

Q3. Suppose an investor did not want to be concerned with the risk of having to reinvest the early repayment of principal. What type of security should he invest in? A security backed by:

A)   non-amortizing assets.

B)   amortizing assets.

C)   automobile loans.

Correct answer is A)

In security backed by non-amortizing assets (e.g. credit cards), early repayment of the principal will not be distributed to investors during the lockout period. Instead, new loans will be purchased. In a security backed by amortizing assets (e.g. automobile loans or mortgages), principal repayments can be distributed to investors.