ikoreaii

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

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

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

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

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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.

ikoreaii

External credit enhancement least likely includes:

A) corporate guarantee.

B) bond insurance.

C) revenue fund.

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

ikoreaii

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.

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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.

ikoreaii

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.

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Both of the reasons are valid.

ikoreaii

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.

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

ikoreaii

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

A) there are time constraints on the deal.

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

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

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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.

ikoreaii

A debt security that is collateralized by emerging market debt would be a(n):

A) CMO.

B) MTN.

C) CDO.

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A CDO (collaterized debt obligation) is a debt obligation that is backed by an underlying diversified pool of business loans, mortgages, emerging market debt, corporate bonds, asset-backed securities, or non-performing loans. A MTN is a medium-term note issued by a corporation. A CMO (collaterized mortgage obligation) is a debt obligation that is backed by mortgages.

ikoreaii

A CDO issued to profit on the spread between the return on the underlying assets and the return paid to investors is referred to as a(n):

A) arbitrage CDO.

B) spread CDO.

C) balance sheet CDO.

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A CDO (collaterized debt obligation) issued to profit on the spread between the return on the underlying assets and the return paid to investors is referred to as an arbitrage CDO. A balance sheet CDO is created by a bank or insurance company wishing to reduce their loan exposure on the balance sheet. Spread CDO is a fabricated term.

ikoreaii

A debt security that is collateralized by various corporate bonds would be a(n):

A) TIP.

B) CDO.

C) CMO.

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A CDO (collaterized debt obligation) is a debt obligation that is backed by an underlying diversified pool of business loans, mortgages, emerging market debt, corporate bonds, asset-backed securities, or non-performing loans. A TIP is a Treasury Inflation-Protected Security. A CMO (collaterized mortgage obligation) is a debt obligation that is backed by mortgages.

ikoreaii

Anthony Schmidt, CFA, makes the following statements while discussing issuance of new debt:

Statement 1:	A best-efforts offering, which is a form of a negotiated offering, occurs when an investment banker purchases an entire issue to resell.
Statement 2:	Registration with the SEC can be avoided with a private placement, but a higher yield will be required to compensate for the limited liquidity.

Are Schmidt’s statements accurate?

A) Both of these statements are accurate.

B) Neither of these statements is accurate.

C) Only one of these statements is accurate.

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Statement 1 is incorrect. A firm commitment (not a best-efforts offering) is an arrangement where the investment banker purchases the entire issue and resells it.
Statement 2 is accurate. Under a private placement, a firm can avoid registration with the SEC, but the buyer will require a higher yield to compensate for the illiquidity of the issue.