More Financial Fragility
12 important questions on More Financial Fragility
Why is the retained risk in a asset backed security so important?
A typical CLO contains which 3 tranches
What are the benefits of securitisation? 4
- Diversification (sell some risk, get some risk back)
- Reduce capital requirements (Only if you sell of an SPV)
- Expansion, funding (Expend your balance sheet)
- Yield enhancement (change the return (and risk) portfolio of the bank, example: swap government bond portfolio into a corporate bond portfolio
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Why did off-balance sheet issuance of CDO collapse after the crisis?
Explain how banks used the CDO daisy chain to transfer risk?
Explain what was the problem of self dealing of CDOs?
How did one of the most important Safeguards of a CDO fail?
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?
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?
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?
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)
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