CFA Level I · CFA Level I Exam · Asset-Backed Security (ABS) Instrument and Market Features
An ABS issuer sets the principal amount of the collateral pool at a level above the total principal of the bonds issued against it. This form of credit enhancement is best described as:
This is overcollateralization. The collateral pool's principal exceeds the principal of the issued bonds, so the extra collateral acts as a loss-absorbing cushion. It differs from a reserve account, which is cash held aside, and from excess spread, which is periodic interest income.
- Aa reserve account
- BovercollateralizationCorrect
- Cexcess spread
Explanation
Overcollateralization means the collateral's value exceeds the face value of the issued securities, creating a cushion against losses. A reserve account is a cash balance set aside. Excess spread is the interest income from collateral exceeding the interest and fees owed on the securities.
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