|"Structured finance" refers to the issuance of securities that are specifically designed and structured to meet the needs of end investors and/or securities issuers. "Structured Insurance" refers to the process by which corporations integrate risk management solutions into their traditional corporate financing activities. Both concepts refer to the part of the global financial market in which securities, derivatives, and insurance converge. Despite the negative connotations associated with these areas of finance in the wake of the credit crisis, the structured finance and insurance arenas remain vibrant and important components of the global capital markets. Not surprisingly, the financial products and structures that are available today have evolved from their pre-crisis counterparts to meet the changing needs of investors, issuers, and regulators and thus look quite different than they did in 2007. In this course, we will focus on the financial products and structures of today and not spend significant time performing an autopsy of products that are now essentially dead and buried.|
The course is divided into three parts. In Part I (the first two weeks), we will review basic corporate finance theory and how structured finance and insurance fit into that theory. We will also discuss the fundamentals of insurance, reinsurance, financial guaranties, and credit derivatives - all of which are essential for understanding the rest of the course. No prior knowledge of (re-)insurance is presumed, so this portion of the course is also intended to be a standalone introduction to (re-)insurance and credit risk management products.
Parts II and III of the class will explore the main products and processes in the structured finance and insurance worlds, respectively. In Part II, we will review the core products of the structured finance marketplace today, including asset-backed securities, asset-backed commercial paper conduits, syndicated loan markets and collateralized loan obligations, and structured project and principal finance. In Part III, we will analyze the main types of structured insurance products, including insurance-linked securities (both natural catastrophe bonds and life insurance securitizations), captives and protected cell companies, multi-line/multi-trigger insurance programs, and event-contingent capital facilities.
This course will not be heavy on mathematics or analytics and is not primarily an asset pricing, cash flow modeling, or financial engineering course. Our perspective instead will be institutional (including legal, tax, accounting, etc.) and product-oriented. The goal is for you to understand the economic functions, benefits, and risks of structured finance and insurance against a framing and unifying backdrop of the theory of corporate finance. You will also learn how to read and digest documents like structured product offering circulars and prospectuses, and rating agency reports.
This course should appeal primarily to those interested in structured products and insurance on the sales and structuring side (banks, reinsurance companies, derivatives dealers, etc.), and on the issuer side (corporate finance and treasury operations and risk management). Auditors, consultants, and other external parties that evaluate structured finance and insurance products may also be interested in the course. Although prospective investors in these products and structures can expect to gain some insights from the class, we will not delve deeply into how these financial instruments fit into broad portfolio management strategies.
|Multiple Choice: |
1. Consider an auto company that sells auto loans originated by its finance division to a SPE. The SPE issues auto loan-backed ABS to finance the purchase of those auto loans. Which of the following is not likely to be a feature of such a securitization? (a) The ABS are non-recourse. (b) The auto loans have been pledged by the SPE as collateral to ABS investors. (c) A trustee has been appointed to monitor the auto loan collateral and represent the interests of the auto company. (d) The auto company does not consolidate the SPE onto its balance sheet for accounting purposes.
2. Consider an ABCDS documented with the ISDA PAUG template based on a reference RMBS rated Aa2 at the time of issue. The protection buyer can terminate the ABCDS early by physically delivering the underlying RMBS to the protection seller after certain events occur. Which of the following events would not entitle the protection buyer to terminate the swap early under the standard ISDA documentation? (a) A scheduled interest payment does not occur on the reference RMBS. (b) A writedown or reduction of principal occurs on the reference RMBS. (c) The underlying RMBS is downgraded from Aa2 to Caa1. (d) A subsequent floating-rate event is reversed. (e) All of (a)-(d) permit the protection buyer to terminate the ABCDS early upon delivery of the reference RMBS.
Please review the attached new issuance reports by S&P for Embarcadero Re and Everglades Re and then answer the questions below about these two structures.
3. Describe the reinsurance contracts in the two structures in XOL notation, and state the attachment and exhaustion points for the two structures. For this question #11, focus on the initial attachment and exhaustion points and not on later dates following any subsequent adjustments or resets.
4. What are the loss adjustment expenses in the reinsurance contracts underlying the two structures assumed during the rating/risk analyses? Express your answer as a percentage of the estimated losses.
5. Describe generally the circumstances under which investors in the notes may receive a different interest payment than the initial contractual interest spreads. (Do not include defaults or reinsurance payments to the sponsor.)
6. Do investors in the two notes bear any credit exposure to the sponsors of the notes? If not, explain why not. If so, which structure manages investors’ credit exposure to the sponsor most effectively (ignoring the credit rating of the sponsor) and why?
7. What is the initial reinsurance premium paid by the two sponsors to the two SPEs? (Express your answer in basis points per annum.) Is the difference between these two premiums broadly consistent with the differences in the risks to which investors are exposed in the two structures? How do you know?
8. Should investors in one of these structures be more concerned about moral hazard than the other? Explain.