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Chapter 09 - CHAPTER 9 RISK MANAGEMENT USING ASSET-BACKED...

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CHAPTER 9 RISK MANAGEMENT USING ASSET-BACKED SECURITIES, LOAN SALES, CREDIT STANDBYS, AND CREDIT DERIVATIVES Goal of This Chapter : The purpose of this chapter is to learn about some of the newer financial instruments that financial institutions have used in recent years to help reduce the risk exposure of their institutions and, in some cases, to aid in generating new sources of fee income and in raising new funds to make loans and investments. Key Topics in This Chapter The Securitization Process Securitization’s Impact and Risks Sales of Loans: Nature and Risks Standby Credits: Pricing and Risks Credit Derivatives and CDOs Benefits and Risks of Credit Derivatives Chapter Outline I. Introduction II. Securitizing Bank Loans and Other Assets A. Nature of Securitization B. The Securitization Process C. Advantages of Securitization D. The Beginnings of Securitization – The Home Mortgage Market 1. Collateralized Mortgage Obligations – CMOs 2. Loan Backed Bonds E. Examples of Other Assets That Have Been Securitized F. The Impact of Securitization Upon Lending Institutions G. Regulators’ Concerns About Securitization Ill. Sales of Loans to Raise Funds A. Nature of Loan Sales B. Loan Participations and Loan Strips C. Reasons Behind Loan Sales D. The Risks in Loan Sales IV. Standby Credit Letters A. The Nature of Standby Credits (Contingent Obligations) B. Types of Standby Credit Letters C. Advantages of Standbys D. Reasons for Rapid Growth of Standbys E. The Structure of Standby Letters of Credit F. The Value and Pricing of Standby Letters 118
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G. Sources of Risk with Standby Credits H. Regulatory Concerns about Standby Credit Arrangements I. Research Studies on Standbys, Loan Sales, and Securitizations V. Credit Derivatives: Contracts for Reducing Credit Risk Exposure on the Balance Sheet A. An Alternative to Securitization B. Credit Swaps C. Credit Options D. Credit Default Swaps E. Credit Linked Notes F. Collateralized Debt Obligations G. Risks Associated With Credit Derivatives VI. Summary of the Chapter Concept Checks 9-1. What does securitization of assets mean? Securitization involves the pooling of groups of earning assets, removing those pooled assets from the bank’s balance sheet, and issuing securities against the pool. As the pooled assets generate interest income and repayments of principal the cash generated by the pooled earning assets flows through to investors who purchased those securities. 9-2. What kinds of assets are most amenable to the securitization process? The best types of assets to pool are high quality, fairly uniform loans, such as home mortgages or credit card receivables. 9-3. What advantages does securitization offer lending institutions? Securitization gives lending institutions the opportunity to use their assets as sources of funds and, in particular, to remove lower-yielding assets from the balance sheet to be replaced with higher-yielding assets.
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