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Answer: Junior bond holder suffer interest payment shortfalls and a principal shortfall, but senior bond holders receive all of their interest and experience no principal shortfall
Based on the table analysis: **Senior Bonds Analysis:** - Senior interest payments are made in full throughout the 5 years (no negative values in senior interest column) - Senior principal of $85 million appears to be fully recovered based on the cash flow patterns **Junior Bonds Analysis:** - In Year 4, there is a negative recovery (-0.0650) indicating junior interest shortfall - The junior bonds face both interest payment shortfalls and principal shortfall - The total terminal available funds ($86.3584 million) are less than owed to bond tranches ($100.6750 million), indicating principal shortfalls **Key Evidence:** - Year 4 shows negative recovery (-0.0650) for junior bonds - The significant gap between terminal available funds ($86.3584M) and total owed ($100.6750M) confirms principal shortfalls - Senior bonds maintain positive cash flows throughout while junior bonds experience deficits Therefore, option C correctly describes the scenario: junior bond holders suffer both interest and principal shortfalls, while senior bond holders receive all interest and experience no principal shortfall.
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Consider a three-tier securitization structure with the following assumptions:
$1 million each, priced at par, paying a fixed 8.5% (i.e., 350 bps over LIBOR flat at 5%).$85 million paying a coupon of LIBOR + 50 bps.$10 million paying a coupon of LIBOR + 500 bps.| Default | Survived | Loan Principal and Interest | Senior Interest | Junior Interest | Excess Spread | Overcollateral | Recovery | QC + Recovery | Equity Flow | QC a/c |
|---|---|---|---|---|---|---|---|---|---|---|
| t | Annual | Cum'l | ||||||||
| 1 | 10 | 10 | 90 | 0.085 | 4.875 | 1 | 1.9750 | 1.7500 | 4.0000 | 5.7500 |
| 2 | 9 | 19 | 81 | 7.6500 | 4.875 | 1 | 1.2100 | 1.2100 | 3.8000 | 4.8100 |
| 3 | 8 | 27 | 73 | 8.8850 | 4.875 | 1 | 0.5300 | 0.5300 | 3.2000 | 3.7300 |
| 4 | 7 | 34 | 66 | 8.2050 | 4.875 | 1 | -0.0650 | -0.0650 | 2.8000 | 2.7350 |
| 5 | 7 | 41 | 59 | 5.6100 | 4.875 | 1 | 2.8000 |
Total Terminal Avail Funds: 86,3584
Owed to Bond Tranches in Year 5: 100,6750
Under this high-default scenario, which of the following statements is true?
A
There is never a year in which either the junior or senior bonds are paid their full interest.
B
Both bond holders (senior and junior) realize all of their interest payments in the first four years, but neither recover their entire obligation in the fifth year (i.e., shortfall for both bond holders)
C
Junior bond holder suffer interest payment shortfalls and a principal shortfall, but senior bond holders receive all of their interest and experience no principal shortfall
D
Both bond holders realize all of their interest payments, in full, and get back the entirety of their principal