Question

A collateralized mortgage obligation (CMO) has the characteristics below. Return on assets 8.75% Senior tranche $400,000,000...

A collateralized mortgage obligation (CMO) has the characteristics below.

Return on assets 8.75%

Senior tranche $400,000,000

Subordinated tranche A $120,000,000

Subordinated tranche B $50,000,000

Value of collateral $600,000,000

Interest paid on liabilities of SPE 7.50%

Fees and expenses 0.60%

Which of the following are most accurate regarding its credit enhancement?

I. There is over collateralization.

II. The investors gain credit enhancement through the excess spread.

A. I only.

B. II only.

C. Both I and II.

D. Neither I nor II.

Homework Answers

Answer #1

Option C is correct, Both I & II only.

There is over collateralization, that is collateral is more than securities issued.

Collaterelization = value of pool = $ 600,000,000

Value of securities issued = $500,000,000 + $120,000,000 + $50,000,000 = $ 670,000,000

Therefore there is over collateralization.

Excess spread is balance of interest income net off fees and interest paid on securities earned by financial institution.

Excess spread = interest on CMO - Interest paid on securities - fees

In case of any kind of defaults or non-performance of assets, excess spread is used to pay investors of securities.

Thus this enhances the creditability of securities.

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