Explanation:
Step 1: Calculate Year 1 Overcollateralization Account Value
Total interest income from collateral pool: (Swap rate + Spread) × Total principal
Interest payment to bondholders = EUR 6,300,000
Excess spread = Interest income - Interest payment = EUR 5,700,000 - EUR 6,300,000 = -EUR 600,000
Maximum annual amount to OC account = EUR 1,500,000
Actual amount to OC account = Min[Excess spread; Maximum amount] = Min[-600,000; 1,500,000] = -600,000
Since the excess spread is negative, the overcollateralization account is depleted and OC₁ = EUR 0
Step 2: Calculate Year 2 Overcollateralization Account Value
Remaining loans after 8 defaults = 100 - 8 = 92 loans
Remaining principal = 92 × EUR 1,000,000 = EUR 92,000,000
Interest income in year 2 = (0.035 + 0.022) × EUR 92,000,000 = EUR 5,244,000
Interest payment to bondholders = EUR 6,300,000
Excess spread = EUR 5,244,000 - EUR 6,300,000 = -EUR 1,056,000
Recovery from defaults = 8 defaults × EUR 1,000,000 × 45% = EUR 3,600,000
OC₂ = (1 + swap rate) × OC₁ + Recovery + Min[Excess spread; Maximum amount]
Therefore, the value of the overcollateralization account at the end of year 2 is EUR 2,544,000.
Ultimate access to all questions.
A manager from the structured credit risk desk at a bank is presenting to a group of newly hired risk analysts on calculating cash flows in a securitization structure. The manager illustrates the procedure with the existing collateral pool of loans and the corresponding liabilities, all with a maturity of 5 years, using the following information:
| Initial number of loans in the collateral pool | 100 |
|---|---|
| Principal amount of each loan | EUR 1,000,000 |
| Total coupon interest to be paid annually on all junior and senior bonds | EUR 6,300,000 |
| Maximum annual amount flowing from the excess spread into the overcollateralization account | EUR 1,500,000 |
| Swap rate per year for all maturities | 3.5% |
| Recovery rate in the event of a loan default | 45% |
The manager makes additional observations as follows:
What is the value of the overcollateralization account at the end of year 2 if there are 8 defaults in year 2?
A
EUR 600,000
B
EUR 1,056,000
C
EUR 2,544,000
D
EUR 3,600,000
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