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Explanation:
Statement D is false (and therefore the correct answer). As shown in the exhibit, recoveries are not immediately paid to equity holders; rather, they are diverted into the Over-Collateralization (OC) account to protect the senior bondholders.
$8.330 million and Excess Spread is $2.655 million. Since Excess Spread = Loan Interest - Bond Interest (L(t) - B), B = 8.330 - 2.655 = $5.675 million.$2.145 to $2.655 million, the amount added to the OC account is capped exactly at $1.750 million.$0.800 million. Recovery rate = 0.800 / 2.0 = 40%.No comments yet.
| (1) | (2) | (3) | (4) | (5) | (6) | (7) | (8) | (9) | (10) | (11) | (12) |\n|---|---|---|---|---|---|---|---|---|---|---|---|\n| t | Defaults Annual d(t) | Cum’l | Survived | Loan Interest L(t) | Excess Spread L(t)-B | Over-collateral OC(t) | Recovery R(t) | OC + Recovery OC(t)+R(t) | Equity Flow | Results | OC a/c |\n| 0 | | | | | | | | | (5.00) | | |\n| 1 | 2.0 | 2.0 | 98.0 | $8.330 | $2.655 | $1.750 | $0.800 | $2.550 | $0.905 | Y | $2.550 |\n| 2 | 2.0 | 4.0 | 96.0 | 8.160 | 2.485 | 1.750 | 0.800 | 2.550 | 0.735 | Y | 5.228 |\n| 3 | 2.0 | 6.0 | 94.0 | 7.990 | 2.315 | 1.750 | 0.800 | 2.550 | 0.565 | Y | 8.039 |\n| 4 | 2.0 | 8.0 | 92.0 | 7.820 | 2.145 | 1.750 | 0.800 | 2.550 | 0.395 | Y | 10.991 |\n| 5 | 2.0 | 10.0 | 90.0 | 97.650 | | | 0.800 | | 9.315 | | 11.540 |\n\nTotal terminal avai funds = L(5) + R(5) + OC a/c (final) 109.990 \nOwed to bond tranches 100.675 \nNote: except for defaults/survive, all amounts in $millions Equity terminal cash flow 9.315 \n\n(Source: Allan Malz, Financial Risk Management: Models, History, and Institutions (Hoboken, NJ: John Wiley & Sons, 2011))\n\nEach of the following is true about this structure EXCEPT which is not?
A
This structure is paying interest to the bondholders of $5.6750 million in each of the five years plus principal repayment in the fifth (5th) year
B
The annual amount diverted to the over-collateralization account is capped at $1.750 million (must be the case, according to the exhibit)
C
The recovery assumption is 40% (must be the case, according to the exhibit)
D
Recovered funds are flowing each year, immediately as recovered, to the equity holders