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  3. question b3 15 marks quotsubprime xyz was a pool of...

Question: question b3 15 marks quotsubprime xyz was a pool of...

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Question B3. (15 marks) Subprime XYZ, was a pool of 2,393 mortgages with a total face value of $430 million A so-called special-purpose vehicle would purchase the mortgages. ...The S.P.V. would finance itself by selling [triple-A rated] bonds. That a vehicle backed by subprime mortgages could borrow at triple-A rates seems like a trick of finance. ...The secret sauce is that the S.P.V. would float.. classes of bonds, from triple-A to a lowly Ba1. this year, when l met with Moodys, an astonishing 27 percent of the mortgage holders in Subprime XYZ were delinquent. Losses on the pool were now estimated at 14 percent to 16 percent- three times the original estimate.... (Roger Lowenstein, Triple-A Failure, NYT 27.04.2008) Assume that the $430 million face value were used to create the following tranches Amount in million $215 $ 86 $ 43 $ 17.2 $ 8.6 $ 8.6 $ 8.6 $ 43 Allocation in % Bond Rating 50% 20% 10% 4% 2% 2% 2% 10% Risk weights for CAR APRA APS 120 20% 20% 20% 20% 50% 100% 100% 350% Aaa Aa2 Aa3 A2 Baa2 Baa3 Ba1 a) Small Bank invested in the aforementioned tranches. Calculate its risk-weighted assets and evaluate if its capital buffer was consistent with its own target of 10 percent minimum capital adequacy ratio at the time of the initial purchase (5 marks) Assets Cash XYZ Aa3 tranche XYZ A2 tranche Loans (risk weight 100%) Small Bank Liabilities and equit $10m Demand $92m $8m $11.4m Equity $8.6m $70m b) Explain how Small Bank is affected if 14 percent of the Subprime XYZ loan pool is written of (2 marks) c) Show the changes in Small Banks balance sheet if instead 16 percent of Subprime (4 marks) XYZ loan pool is written off. Explain what problem Small Bank faces d) Assume that Small Bank invested $20m directly in subprime mortgages equivalent in risk to the ones in XYZ, instead of the tranches. Explain if this would have been better or worse for Small Bank. Also check if Small Banks initial capital of 8m would have been sufficient to grant the aforementioned $20m in subprime loans, additionally to the existing $70m loans (4 marks)

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