- Johnson turns his attention to ABSs. Which of the following is the least important factor considered by rating agencies in assigning a credit rating to ABS? A) Quality of the seller/servicer. B) Credit quality of the collateral. C) Cash flow stress and payment structure. D) Covenants of the lending agreement. 2. Taylor explains to Johnson that there are major differences between ABS and corporate bonds in terms of credit risk. Which of the following is a major difference? ABS have: A) complete predictability of cash flows and no operational risk. B) the same predictability of cash flows but a lower operational risk. C) a smaller predictability of cash flows due to the higher operational risk. D) a greater predictability of cash flows due to the absence of operational risk. 3. Which of the following assumptions is least likely a limitation of the cash flow yield measure? A) All cash flows will come in on schedule. B) All interim cash flows are reinvested at the cash flow yield. C) Default risk associated with the underlying loans is constant over the life of the security. D) MBS or ABSs are held until the final payout. T/G
Wow, these are kinda hard… Here’s my shot at it A B C
D C C
D C C
D, B, C
ABS have higher operational risk?
- The correct answer was D) Covenants of the lending agreement. Lending agreement covenants are not a major factor considered by rating agencies. The role of the servicer is critical in an asset-backed security transaction. Therefore, rating agencies look at the ability of a servicer to perform all the activities that a servicer will be responsible for. The rating companies will look at the underlying borrower’s ability to pay and the borrower’s equity in the asset. The payment structure of an asset-backed security transaction can be either a passthrough or pay through structure. This has important implications for the distribution of the cash flows to the different tranches of the security. 2. The correct answer was D) a greater predictability of cash flows due to the absence of operational risk. In an ABS transaction the role of the servicer is to simply collect the cash flows. There is no active management with respect to the collateral and so very little operational risk associated with cash flows. Conversely, corporate management includes tremendous operational risk. 3. The correct answer was C) Default risk associated with the underlying loans is constant over the life of the security. The cash flow yield measure does not rely on any credit risk assumption. The other assumptions apply to the cash flow yield, and all represent a weakness of the metric, because they are not practical in a real-life context. T/G
D B C not sure about the second out. definitely less operating risk but not sure about predictability of cash flows.
Ah, make sense. not complete predictability over the cash flow, but higher than corporate bond