Corrier reminds the investment policy committee, “Our auto loan-backed securities face the same prepayment risk that our collateralized mortgage obligations (CMOs) do.” Bakerslee points out that the firm’s investments in credit card receivable backed securities will still be in the lockout period for another two years, “so we don’t have to worry about prepayment of principal on those right now.” Regarding the statements made by Bakerslee and Corrier about prepayment risk: A) Bakerslee’s statement is correct; Corrier’s statement is incorrect. B) Bakerslee’s statement is incorrect; Corrier’s statement is incorrect. C) Bakerslee’s statement is incorrect; Corrier’s statement is correct. Your answer: B was incorrect. The correct answer was A) Bakerslee’s statement is correct; Corrier’s statement is incorrect. No principal is paid to the ABS holders during the lockout period, so there can be no prepayment risk at that time. Bakerslee’s statement is correct. The prepayments from a pool of auto loans are much more predictable and much less dependent on interest rate changes than prepayments on mortgage loans. Corrier’s statement is incorrect. (Study Session 15, LOS 56.b) ------ questions like these are really frustrating because when i read it i assumed she was wrong on the ABS because credit card recievables can still pay out interest during the lockout period if there is an early amortization trigger. clearly schweser was not thinking this way. am i technically right? and is there anyway to tell in question that they do not want you to consider the early amoritization trigger?
Good question. During the lockout period for credit card receivables, any early principal repayment, while certainly allowable (as opposed to a CMBS that may have a prepayment penalty) will be reinvested into new credit card receivables. Here’s something to note. The assets in a non-amortizing ABS can change. The assets in an amortizing ABS cannot change. Best in June!
this is true but there are certain conditions where principal can be retired early. reading 56 talks about call provisions such as a specific date reached, collateral value falling, and insurer calls. it talks about early amortization triggers (the most common of which is when the 3 month average excess spread earned on receviables declines to zero). this same page even says “even though there is no principal repayment schedule for credit card borrowers, an early amortization trigger creates the potential for contraction risk in a receviables-backed structure.” based on that, i think the question is at best poorly worded, if not wrong. at the very least, give me some language that says “most often” or “under no triggers” or something like that.
i realize that call provisions such as a specific date reached, collateral value falling, and insurer calls are in general for nonamortizing loans and not specifically applicable to cc receievables. just was listing examples in general. but question still stands on the amortization trigger.
Good question, then. I guess I like to think simplistically…I find overthinking things (while accurate) can actually backfire.
i guess since it doesnt specifically mention any events will occur during the lockout period to trigger the early amoritzation we should “simplistically assume” that nothing will occur. ugh.