Home / Summaries / Class notes - Financial Markets and institutions / risk-cdo-default

More Financial Fragility

12 important questions on More Financial Fragility

Why is the retained risk in a asset backed security so important?

The retained risk is the liquidity back-stop of the equity tranche in a security. When the security becomes illiquid and the capital dries up, the assets are placed back on the balance sheet of the originator (a bank for instance). Due to the capital requirements banks want to transfer some of the risk through securitising risky assets. But not all risk is removed when the assets are off the balance sheet

A typical CLO contains which 3 tranches

senior debt, mezzanine debt and an equity trance. The composition of the tranches depends on the probability of default of the underlying assets.

What are the benefits of securitisation? 4

  1. Diversification (sell some risk, get some risk back)
  2. Reduce capital requirements (Only if you sell of an SPV)
  3. Expansion, funding (Expend your balance sheet)
  4. Yield enhancement (change the return (and risk) portfolio of the bank, example: swap government bond portfolio into a corporate bond portfolio
  • Higher grades + faster learning
  • Never study anything twice
  • 100% sure, 100% understanding
Discover Study Smart
Testimonial person
Sophia
Law student
Quotes

For my 1st exam I got a C. Then, I started looking for ways to learn better and I came across Study Smart. Since then I have scored a A+, A, A- and another A. I highly recommend it to everyone who wants to hear it. I am so happy with it!!

Testimonial person
John
Economics Student
Quotes

I was struggling to finish all my first-year subjects for 3 years. Then I discovered Study Smart, which helped me to finish all of them within 3 months.

Testimonial person
Sara
Public Administration Student
Quotes

Because of StudySmart, things are going well in many ways. Before, I always had study stress and no time for anything. Now I feel calm and confident (because of the program). I used to score a B, now I usually score an A or A+.

Testimonial person
Mary
Business Student
Quotes

Hey Chris, I really want to thank you very much for developing the platform, I usually got around C for my exams, now I scored an A+, an A and a A- !!

Testimonial person
Melanie
Psychology Student
Quotes

Since using Study Smart, my average has increased significantly. I even completed a statistics course with a A+ while I'm bad at statistics. I took on extra courses this year, because of Study Smart. Thanks so much!

Testimonial person
Jane
Nursing Studies
Quotes

Ever since I started studying with StudySmart I passed all my exams !!! No more re-sits!! At first, I was happy with a pass and now I only get good grades. Many thanks!

Testimonial person
Rose
Political Science Student
Quotes

I aced all the courses I studied with Study Smart. For law, I first scored a D, and now an A! I’m 100% sure that I’ll pass all the courses I study with Study Smart.

Testimonial person
Tina
Medicine Student
Quotes

I always thought I studied well. My grades were fine. I could never have imagined that applying these study skills would have such a huge and direct impact on my grades, my speed and the pleasure I have in learning.

Testimonial person
Julie
Marketing Student
Quotes

For the first time, I finally feel totally confident about the way I learn. I have the perfect overview and make great progress in terms of speed and the grades I get. Thanks, Chris!

Testimonial person
Matt
Industrial Engineering Student
Quotes

I immediately started to enjoy learning again, and my grades soared. All of a sudden, everything went better. I highly recommend Study Smart to all students..

Testimonial person
Emma
Law Student
Quotes

Being able to create my materials online made the process of studying so much smoother and quicker. I no longer have to spend a huge amount of my time on creating my summaries.

Testimonial person
Michael
Psychology Student
Quotes

At first, my notes were a mess. Now I use Study Smart to take my notes in a perfectly structured way. It helps me to save a lot of time and do other things I enjoy.

Testimonial person
Emily
Teacher
Quotes

Students that study with Study Smart get better grades. The system applies all the learning methods in such a way that both well-performing students and students who struggle perform much better.

Testimonial person
Richard
Literature Student
Quotes

Hi Chris, I would like to thank you very much. Last year I scored C on a course, and this year I got an A+ thanks to your method! Thank you very much!

Testimonial person
Madison
Parent
Quotes

The largest effect is that my child is more enthusiastic about school! Every parent wants their children to be happy at school, Study Smart made it happen.

Testimonial person
Robert
Accountant Student
Quotes

In high school, I failed several exams, and that has really changed now. I actually needed this tool very much back then. Since I started studying with StudySmart, I haven't had any D's. My average score is now an A and those are results I would have never had in the past

Testimonial person
James
Business and Science Student
Quotes

With my old method, I passed only 3 out of 8 courses. Since I started taking my notes digitally in Study Smart, I have passed all my courses on the first try. For me, StudySmart takes away the stress of wondering if I will pass or not.

Testimonial person
Christopher
Veterinarian Student
Quotes

Thanks to StudySmart, I passed all my exams, and with better grades than before! On top of that, I have mastered a very good study method now, which I am confident will help me earn my degree.

Why did off-balance sheet issuance of CDO collapse after the crisis?

No one trusted the securities anymore because there was a huge information asymmetry between the market and the issuers. Thus investors refused to invest in securities because they didn't thought to know the risks, although the securities were ok.

Explain how banks used the CDO daisy chain to transfer risk?

(Madeliefjes ketting). Here's how the Wall Street Money Machine worked in the run-up to the financial collapse: Banks created CDOs from mortgage-backed securities. Banks often retained the large top portion, called the "Super Senior." The bottom portion, or "Equity," was often sold off to hedge funds. The middle portion, or "Mezzanine," often went into new CDOs. The main buyers of those new CDOs were once again the banks. Through this structure you change the risk profile from a bond payment to an equity share, mezzanine and super senior debt.

Explain what was the problem of self dealing of CDOs?

Through securitising the debt, the structure of debt changes but if the bank keeps adding new CDOs without selling them of, the risk is contained within the bank. So there are high volumes but, dealing is with the bank it self, so no actual risk transfer.

How did one of the most important Safeguards of a CDO fail?

One of the most important safeguards of a CDO was the independent manager of the CDO. Those managers were supposed to protect the interest of the CDO. However, management firms are reliant on dealer banks businesses. There are very high fees for each deal. Thus in order to generate profit, they needed deals to happen.

What can we remark with hindsight about CDO before the crisis?

  • Products are to complicated to be priced ("Dog and the Frisbee")
  • Self-dealing led to an overbuyant market
  • Nearly half of the nearly trillion dollars in losses to the global banking system came from CDOs
  • Incestuous cross holding increased potential for contagion

What is a total return swap? What does it protect for? What are its advantages?

Agreement to exchange all cash flows emerging from a default able or risk free investment (so market risk too)
Protected: Coupon, Price appreciation of the bond (if positive) and principal (if no default), recovery (if default)
Advantages: Exposure(without upfront financing of the loan), protection without consent of underlying, easier to short (buy protection while you do not own the underlying).

What is a Credit Default Swap? What does it protect for? What are its advantages?

Trade of the credit risk of a loan or security.
The Protected: Pay fee (periodically or up-front), upon default of reference entity: receive payment (settlement: cash (recovery risk retained), Physical delivery (possible bond squeeze in default)
The Protector: Pay Default Payment
Advantages: Similar to TRR SWAP, pure credit risk tradem, standardisation (ISDA) (default definition, settlement, contract type)

What is a Central Counterparty Clearing House (CCP)? What does it do?

CCP means a legal person that interposes itself between the counter parties to the contracts traded on one or more financial markets, becoming the buyer to every seller and the seller to every buyer.

There are two main processes that are carried out by CCPs: clearing and settlement of market transactions. Clearing relates to identifying the obligations of both parties on either side of a transaction. Settlement occurs when the final transfer of securities and funds occur.

What financial assets can one trade (2) and on what markets (2)?

  • securities (Bonds, equity)
  • Derivatives (forwards, futures, options swaps)
  • Multilateral trade (Exchange, Multilateral Trading Facility (MTF), Dark pool)
  • Bilateral trade (over-the counter)

The question on the page originate from the summary of the following study material:

Financial Markets and institutions

View summary
  • A unique study and practice tool
  • Never study anything twice again
  • Get the grades you hope for
  • 100% sure, 100% understanding
Remember faster, study better. Scientifically proven.
Trustpilot Logo

Summaries related to Traditional Banking