Financial Risk Manager Part 2
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A credit manager, with expertise in the 2007-2009 US subprime mortgage crisis, oversees a bank's structured credit portfolio. The manager's task includes identifying potential issues arising from information exchange discrepancies (frictions) among participants involved in the securitization process. Identify the correct pairing of a potential friction in the securitization process and an appropriate method to mitigate that friction.
A
Friction between the asset manager and the investor: Adverse selection problem. This problem can be mitigated by the asset manager charging due diligence fees to the investor.
B
Friction between the arranger and the originator: Model error problem. This problem can be mitigated by the arranger providing a credit enhancement to the securitized products with its own funding
C
Friction between the investor and credit rating agencies: Principal-agent conflict. This problem can be mitigated by requiring credit rating agencies to be paid by originators and not by investors for their rating services.
D
Friction between the servicer and the mortgagor: Moral hazard problem. This problem can be mitigated by requiring the mortgagor to escrow funds for insurance and tax payments.