Financial Risk Manager Part 1

The originate-to-distribute (OTD) business model is a practice where the originators of mortgages or other types of loans repackage these assets and sell them to third parties. This model is the opposite of the traditional originate-to-keep (OTK) model where the owners of mortgages and other loans keep these assets in their balance sheets until maturity. The OTD model has several benefits from the perspective of the originator, usually banks. It introduces specialization in the lending process as functions initially designated for a single firm are now split among several firms. It also reduces banks' reliance on the traditional sources of capital, such as deposits and rights issues. Furthermore, it introduces flexibility into banks' financial statements and helps them diversify some risks.

Choice B is incorrect. Originate-to-keep refers to the traditional banking model where banks originate loans and keep them on their balance sheets until they are repaid. This is different from the practice described in the question, which involves selling off the mortgages as securities.

Choice C is incorrect. Principal-agent engineering does not refer to any specific practice in financial markets. It's a term that might be used in discussions of agency theory, which deals with issues like moral hazard and conflicts of interest between principals (like shareholders) and agents (like managers or brokers). It doesn't have anything to do with mortgage origination or securitization.

Choice D is incorrect. A credit default swap is a derivative instrument used to transfer credit risk, not a practice of approving mortgages for securitization.