Question

Bond Class Par Value Credit Rating

Class A     $150,000,000 AAA

Class B $ 50,000,000 AA

Class C $ 25,000,000 A

Total $ 175,000,000

9) At what level of loss would Class B experience a loss?

a) $25MM

b) $26MM

c) $75MM

10) The creation of a bond classes with a waterfall structure for sharing losses is referred to as:

a) Credit Tranching

b) Time Tranching

c) Excess Reserves

11) How would this structure above best be described?

a) A pool of conforming mortgages as collateral.

b) Senior/Subordinated Structure.

c) All classes are guaranteed by a government-sponsored enterprise (GSE).

12) The following feature of this commercial mortgage-backed security has most likely improved its credit rating?

a) Balloon payments.

b) Call Protection.

c) Subordination.

Answer 1

Q9) B) 26mm

Explanation: In this case, firstly the lower class C will bear all the losses, once the Class C does not have any amount left to bear the loss, then the loss is to be borne by Class B. In this case, first 25mm is borne by class C and then by Class B. So, if the loss becomes 26mm then Class B will start bearing the loss.

Q10) A) Credit Tranching

Explanation: The creation of waterfall structure based on loss sharing is called credit tranching.

Q11) Senior / Subordinated Structure

Explanation: It is senior/subordinated structure, as the profit will be absorbed first by class A and losses will be first absorbed by class C.

Q12) C) Subordination

Explanation: Subordination helps to improve the the credit rating. Whereas balloon payment increases the risk which decreases the credit rating and Call protection provides protection against prepayment risk.