CFA Level I · CFA Level I Exam · Fixed-Income Securitization
Compared with internal credit enhancement, external credit enhancement such as a third-party guarantee most likely exposes the investor to:
External enhancement exposes the investor to the guarantor's credit risk as well as the collateral's. The protection is only as strong as the third party providing it, unlike internal methods such as excess spread, which are built into the structure.
- Athe credit risk of the guarantor in addition to the collateralCorrect
- Bless exposure to the collateral performance and no counterparty risk
- Cthe same structure as excess spread within the securitization
Explanation
External enhancement comes from a third party, such as a guarantee or bond insurance, so its value depends on the guarantor's creditworthiness. Internal enhancement such as excess spread, subordination or overcollateralization is built into the structure. A downgrade of the guarantor can reduce the value of the protection.
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