In the first example of R23, there’s a residential mortgage loan categorised as type 4. The reason being given for the amount being unknown is that even loans with high LTV could be subject to default.
Whereas, in the first practice problem, a manufacturing co. are considered type 1. Why would this not be a suspect for default ?
No need to consider default/credit risk when categorizing types of liability. If that were the case, then most type II and type III liabilities (e.g. callable bonds, floating rate bonds, etc) would be type IV liabilities.
In your example, the bond’s coupon payments and payment dates are known, therefore type 1.
residential mortgage loans are a type 4 NOT because they are subject to default but because a homeowner can refinance their mortgage at any point, if interest rates go down… or they could slow down the projected prepayment significantly if interest rates go up… So the timing on your big MBS is unknown because of interest rates…
But I still dont know what a manufacturing co has to do with liabilities…
Assuming the bonds are fixed, not floating (I haven’t seen this question, the liability from the Co.'s point of view is Type 1, because both time and amount are known. For example, they know they have to make a 2% coupon payment every 6 months.
Apart from that, you actually do NOT know many other things. One, for instance is default risk DOES make for a factor.
“Default risk also affects the projected amount of the cash flow for each date. Even if the average loan to value ratio is 80%, indicating high - quality mortgages, some loans could have higher ratios and be more subject to default, especially if home prices decline.”