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FRM Part II · FRM Exam Part II · Structured Credit Risk

A securitization's collateral pays a weighted average coupon of 7.0% on USD 100 million. Servicing and trustee fees are 0.5% of the pool. Notes have a total outstanding balance of USD 100 million with a weighted average cost of 5.0%. Annual pool credit losses are expected at 1.0%. Assuming all figures apply to the same balance, what is the annual excess spread as a percentage of the pool after expected losses are considered?

The annual excess spread after expected losses is 0.5% of the pool. Collateral income of 7.0% less servicing costs of 0.5% and note interest of 5.0% leaves 1.5%, and expected credit losses of 1.0% then reduce this to 0.5%, which is available as first-loss credit enhancement.

  1. A0.5%Correct
  2. B1.5%
  3. C2.0%
  4. D1.0%

Explanation

Excess spread before losses = 7.0% - 0.5% - 5.0% = 1.5%. Subtracting expected losses of 1.0% leaves 0.5%. Option 1.5% omits losses, and 2.0% omits servicing fees.

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