QFC Financial Engineering & Structured Products

Question 1

In a securitization transaction, what is the primary purpose of a Special Purpose Vehicle (SPV)?

Accepted Answer

To isolate the securitized assets from the originator's bankruptcy risk

Answer

To provide credit enhancement directly to bond investors

Answer

To hedge interest rate risk embedded in the asset pool

Answer

To manage prepayment speeds of the underlying loans

Question 2

Which of the following best describes 'tranching' in a CDO structure?

Accepted Answer

Splitting a pool of cash flows into different risk/return classes with varying priority of payment

Answer

Dividing assets by maturity date to match liability duration

Answer

Diversifying the asset pool across multiple industry sectors

Answer

Hedging currency risk in cross-border structured products

Question 3

What does the 'waterfall' describe in a CDO structure?

Accepted Answer

The sequential order in which cash flows are distributed to different tranches

Answer

A mechanism that accelerates amortization when asset values decline

Answer

A liquidity facility that ensures timely payment to all tranche holders

Answer

The process by which collateral is substituted in an actively managed CDO

Question 4

Which asset class typically backs a Collateralized Loan Obligation (CLO)?

Accepted Answer

Leveraged corporate loans

Answer

Residential mortgage loans

Answer

Credit card receivables

Answer

Investment-grade government bonds

Question 5

In asset-backed securities, what does 'overcollateralization' as a credit enhancement technique involve?

Accepted Answer

Pledging assets whose value exceeds the face value of the issued securities

Answer

Issuing more bonds than the underlying asset pool can support

Answer

Using interest rate derivatives to enhance yield on lower-rated tranches

Answer

Purchasing insurance from the originator against pool credit losses

Question 6

What fundamentally distinguishes a synthetic CDO from a cash CDO?

Accepted Answer

A synthetic CDO gains credit exposure through credit default swaps rather than physical asset ownership

Answer

A synthetic CDO holds physical bonds while a cash CDO holds equities

Answer

A synthetic CDO is always unrated while cash CDOs require AAA senior tranches

Answer

A synthetic CDO uses leverage while a cash CDO does not

Question 7

Which of the following best describes the 'equity tranche' in a structured finance transaction?

Accepted Answer

The first-loss piece that absorbs initial credit losses from the underlying asset pool

Answer

The most senior class that bears the least credit risk in the structure

Answer

A floating-rate note indexed to a benchmark rate plus a spread

Answer

A guaranteed investment contract provided by a highly rated financial institution