Chapter 8 Securitization and the Credit Crisis of 2007

15) Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 85%, mezzanine 10%, and equity 5%. (The portfolios of subprime mortgages have the same default rates.) An ABS CDO is then created from the mezzanine tranches with the same allocation of principal. How high can losses on the mortgages be before the mezzanine tranche of the ABD CDO bears losses?

A) 5.0%

B) 5.5%

C) 6.0%

D) 6.5%

16) Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 85%, mezzanine 10%, and equity 5%. (The portfolios of subprime mortgages have the same default rates.) An ABS CDO is then created from the mezzanine tranches with the same allocation of principal. How high can losses on the mortgages be before the senior tranche of the ABS CDO bears losses?

A) 5.5%

B) 6.0%

C) 6.5%

D) 7.0%

17) Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 94.5% (rated AAA), mezzanine 0.1% (rated BBB), and equity 5% (rated C). The portfolios of subprime mortgages have the same default rates. An ABS CDO is then created from the mezzanine tranches. Which of the following is true?

A) The ABS CDO tranches should have similar ratings ranging from AAA to C

B) The ABS CDO tranches should all be rated BBB

C) The ABS CDO tranches should all be rated C

D) The ABS CDO tranches are almost worthless because the mezzanine tranches are so thin

18) Which of the following describes regulatory arbitrage?

A) Finding a way of reducing capital requirements without changing the risks being taken

B) Buying products that are not subject to regulation

C) Shorting products that are not subject to regulation

D) Trading with the government

19) Which of the following describes a subprime mortgage?

A) The rate of interest is less than the prime rate of interest

B) The loan-to-value ratio is below average

C) The life of the mortgage is less than 25 years

D) The credit risk is high

20) Which of the following would be described by the term "liar loan"?

A) A situation where the lender concealed information from the borrower

B) A situation where the lender lied to the borrower about the interest rate

C) A situation where the borrower lied about his or her income

D) None of the above