Tricky Risk Management Question

I am paraphrasing a Schweser question: You hold a portfolio of securitized sub-prime mortgages. As a result of the weak economy in the US, morgage borrowers are defaulting on their loans causing the MBS to lose money. Your porfolio has decreased in value as a result. Correct or incorrect: You are experiencing market risk and credit risk. Answer: Market Risk Credit Risk Incorrect Correct The rationale is that the borrowers are defaulting; therefore there is credit risk. Because (according to the answer key) there is no macro economic risk such as rising interest rates, there is no market risk. My question: If you have a portfolio of securitized mortgages, they are issued by an SPV (the counterparty). Unless the SPV defaults are you not dealing with market risk rather than credit risk? As the borrowers default, your securities decline in value - market risk? Please let me know what you think…

I thought market risk too!

I said it before…I am saying it again. Schweser questions suffers severly from “Frame Dependent” bias.

can you point to us the original question also? i dont think investors are immuned from credit risks given mbs are pass-thru securities. spv only makes sure the risks are re-distributed among different tranches.

" As a result of the weak economy in the US,…" isn’t that a macro economic risk?

Don’t they define market risk as anything related to developments in financial markets (equity prices, interest rates, FX rates). On that basis, isn’t this clearly credit risk? I don’t get why you are bringing SPVs into this at all. The loss experience is borne because of the underlying credit quality of the borrowers. Addendum: I DO now get why you are asking this. I suggest you move on/get a life. Being able to slap a label on something like that is pointless. But I agree it would be market risk, imo

Random, the question was from the Schweser class (not in the materials). CareerChange - I thought the same. Etienne - CFAI asks these types of questions which is why I’m pursuing it. I’m hoping to pass so I can get my life back. As for the SPVs, I thought, perhaps incorrectly given your responses, that the SPV (issuer of the securitized mortgages) would be the counterparty. Counterparty risk = credit risk.

I think you should forget about this example: if you hold a bond, and the issuer has problems = credit risk ok, but the market is always going to reflect that in the price of the bond in secondary market, so this would imply that you would always have market risk So to “isolate” market risk itself, the movement of the price (for good or bad) has to happen because of something different than credit problems Applied to this MBS, you have credit risk, not market risk. But I agree with Etienne, when you see this kind of problems, just don´t think and move on

And please somebody from the fixed income world correct me if I am wrong, but the SPV is just the “envelope” of the underlying mortgages. For the holder of the MBS, it only means that if the “owner” of the SPV defaults, its creditors can not chase the assets inside the SPV because it is a separated entity (so the collateral of the MBS is only for the MBS, working as a credit enhancement)

bear stearns invested heavily on mbs issued by fannie mae. what had happened?

rand0m Wrote: ------------------------------------------------------- > bear stearns invested heavily on mbs issued by > fannie mae. what had happened? do u suggest bear stearns should go after fannie mae?