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FRM Part II · FRM Exam Part II · An Introduction to Securitisation

An originator wants to raise the credit rating of a senior tranche without changing the collateral pool. Which action is an example of internal credit enhancement?

Making the junior tranches thicker increases subordination, which is internal credit enhancement because it comes from the deal's own structure. Guarantees, letters of credit and surety bonds are external enhancements that rely on a third party's creditworthiness rather than the structure of the securitisation.

  1. AIncreasing the subordination by making the junior tranches thickerCorrect
  2. BBuying a third-party monoline guarantee on the senior tranche
  3. CObtaining a letter of credit from an external bank
  4. DPurchasing a surety bond from an insurer

Explanation

Internal enhancement comes from the deal structure itself: subordination, overcollateralisation, excess spread and reserve accounts. Monoline wraps, letters of credit and surety bonds are external enhancements that depend on a third party's credit quality.

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