Explanation:
Step 1: Calculate Total Interest Income
$100 million$100 million × (LIBOR + 2%)Step 2: Calculate Total Interest Expenses
Senior debt expense:
$90 million$90 million × (LIBOR + 1%)Senior expenses:
$100 million × 20 bps (0.2%)$100 million × 0.2%Step 3: Calculate Net Excess Spread Net excess spread = Total interest income - Total interest expenses
= [$100 million × (LIBOR + 2%)] - [$90 million × (LIBOR + 1%) + $100 million × 0.2%]
= $100 million × LIBOR + $100 million × 2% - $90 million × LIBOR - $90 million × 1% - $100 million × 0.2%
= ($100 million - $90 million) × LIBOR + ($100 million × 2% - $90 million × 1% - $100 million × 0.2%)
= $10 million × LIBOR + ($2 million - $0.9 million - $0.2 million)
= $10 million × LIBOR + $0.9 million
= $10 million × (LIBOR + 9%)
However, this represents the gross excess spread. The subordinated debt (equity) receives the net excess spread after all expenses.
Step 4: Verify the Correct Answer
The net excess spread is:
$10 million × (LIBOR + 2% - 1% - 0.2%) = $10 million × (LIBOR + 0.8%)
But wait, let me recalculate carefully:
Income: $100 million × (LIBOR + 2%)
Expenses:
$90 million × (LIBOR + 1%)$100 million × 0.2%Net excess spread:
= $100 million × (LIBOR + 2%) - $90 million × (LIBOR + 1%) - $100 million × 0.2%
= $100 million × LIBOR + $2 million - $90 million × LIBOR - $0.9 million - $0.2 million
= $10 million × LIBOR + $0.9 million
= $10 million × (LIBOR + 9%)
This matches option C: $10 million × (LIBOR + 7%) is incorrect. The correct calculation shows $10 million × (LIBOR + 9%).
Correction: I made an arithmetic error. Let me recalculate:
$100 million × 2% = $2 million
$90 million × 1% = $0.9 million
$100 million × 0.2% = $0.2 million
Net = $2 million - $0.9 million - $0.2 million = $0.9 million
So net excess spread = $10 million × LIBOR + $0.9 million = $10 million × (LIBOR + 9%)
Therefore, the correct answer is D: $10 million × (LIBOR + 9%).
Ultimate access to all questions.
Assume the originator securitizes a $100 million loan portfolio that pays LIBOR plus 200 bps. Senior expenses of the SPE amount to 20 bps. The SPE issues only two classes of securities: senior debt with face value of $90 million and subordinated debt with face value of $10 million, such that the subordinated debt "functions as equity". The coupon on the senior debt is LIBOR plus 100 bps. The subordinated debt (equity) gets an interest rate equal to the realized net excess spread. What is the net excess spread?
A
$10 million × (LIBOR + 3%)
B
$10 million × (LIBOR + 5%)
C
$10 million × (LIBOR + 7%)
D
$10 million × (LIBOR + 9%)
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