Collateralization vs over collateralization

[jyothi1965]

David

The FRM 2007 practice exam is full of "fantastic and insightful" questions designed to knock the confidence out of you (Phew! today was a bad day!!) by a combination of wrong questions, wrong answers, and questions which you cant find reference to in the assigned readings even if you hunt with a microscope. GARP 'has to showcase that FRM is tough; they have made it really bad in every sense. I give up!! *%$###!!!!

one question that bugged me was:

All the following are different ways to structure credit enhancement in a securatization except:

1. cash reserve account
2. subordinated tranches of securitised debt
3. collateralization
4. excess spread

Tranching is one way of credit enhancement of the upper tranches when compared to the subordinated one. The choice is 3 as per GARP.

If you see the assigned readings , the word is overcollaterlization. Now by giving a choice of collaterlization and then saying it is not the same as overcollaterlization is really splitting hairs!!

Any difference or semantics at play?

J

 

[David Harper CFA FRM]

I hate it, too, it is legalistic. It might be more defensible if it qualified the choices as "internal credit enhancement" O/C is a 'term of art,' it's true so i guess this is correct, but i agree: legalistic/semantic....It is a test of Culp's list where, unfortunately, you might do better to know a little less...

 

[mikey10011]

David,

This might be off-topic which is why I did not want to create a new post but if "super senior" tranches are super safe because they are at the top of the totem pole, why did Merrill Lynch write them off this past June instead of holding them to maturity?

http://www.ml.com/index.asp?id=7695_7696_8149_88278_101366_103431

Also in regards to the "originate-and-distribute" business model, why did the investment banks hold so much securities on their balance sheets? I thought the whole point of the model was to "distribute" them?

 

[mikey10011]

I just went through Credit C slides 34 & 35 and it appears that my question above on the super-senior tranche relates to the tranched portfolio default swap (TPDS) . I've read Meissner (p. 49) and saw

http://www.bionicturtle.com/learn/article/tranched_portfolio_default_swap/

To be honest I still don't understand TPDS: I am still puzzled why "super senior" tranches at the top of the totem pole caused so much trouble--or specifically what went wrong with Merrill's TPDSs. I know that you probably don't have the particulars but could you give a screencast on what probably led to Merrill's massive writeoffs?

Also could you recommend some supplementary readings on TPDS? (I google'd TPDS but what I found was not helpful.)

Another off-topic question: Option adjustable rate mortgages are due to reset next summer ["According to Credit Suisse, monthly option recasts are expected to accelerate starting in April, 2009, from $5 billion to a peak of about $10 billion in January, 2010"], which could lead to a tsunami-sized wave of defaults (that obviously hasn't happened yet since the resets have yet to occur).

http://www.businessweek.com/lifestyle/content/jun2008/bw2008065_526168.htm

Do you think that the credit rating agencies have *already* expressed their "opinion" on this yet-to-occur event?

p.s., With tongue in cheek <wink>, please make it clear that your are NOT offering "investment advice" (see second paragraph)
http://graphics8.nytimes.com/packages/pdf/business/22nocera-blog.pdf