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Answer: EUR 2,544,000
## Explanation **Step 1: Calculate Year 1 Overcollateralization Account Value** - Total interest income from collateral pool: (Swap rate + Spread) × Total principal - Swap rate = 3.5% = 0.035 - Spread = 2.2% = 0.022 - Total principal = 100 loans × EUR 1,000,000 = EUR 100,000,000 - Interest income = (0.035 + 0.022) × EUR 100,000,000 = EUR 5,700,000 - 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] - OC₂ = (1 + 0.035) × 0 + EUR 3,600,000 + Min[-1,056,000; 1,500,000] - OC₂ = EUR 3,600,000 + (-1,056,000) = EUR 2,544,000 Therefore, the value of the overcollateralization account at the end of year 2 is **EUR 2,544,000**.
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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