Benefits of Securitization
The Securitization Process Securitization involves transferring ownership of assets from original owners (usually individual borrowers) to a special legal entity. This entity, in return, issues asset-backed securities backed by these transferred assets. The pool of securitized assets from which cash…
Describe Securitization
A hypothetical financial institution, BCG Bank, decides to raise a $100 million loan by securitizing loans rather than issuing corporate bonds. The company sets up a legal entity, Loan Trust, to which it sells the loans. Such a legal entity…
Understanding Fixed-income Risk and Return
There are 3 sources of return in a fixed-income security: receipt of the promised coupon and principal payments; reinvestment of coupon payments; and/or capital gains or losses on the sale of the bond prior to maturity. A discount bond offers…
Macaulay, Modified, and Effective Durations
The duration of a bond measures the sensitivity of the bond’s full price (including accrued interest) to changes in the bond’s yield-to-maturity or, more generally, changes in benchmark interest rates. Bond duration estimates changes in bond price assuming that variables…
Effective Duration-Measure of Interest Rate Risk
Another approach to assessing interest rate risk of a bond is to estimate the percentage change in price against a change in the benchmark yield curve, such as the government par curve. The effective duration is defined as the sensitivity…
Financial Ratios Used in Credit Analysis
Key credit analysis measures fall into 4 different groups: Profitability and Cash Flows It is from operating cash flows that companies can service their debt payments. The operating income can be obtained by subtracting operating expenses from operating revenues, and…
The Credit Quality of a Corporate Bond Issuer
To illustrate how to evaluate the credit quality of a corporation, we will look at CVS, a US-based healthcare company. You will be in the shoes of a banker that needs to assess the creditworthiness of CVS. Using the financial…
Factors That Influence the Level and Volatility of Yield Spreads
As we saw previously, the yield on a government bond (the benchmark) is: $$\text{Goverment bond yield = Real risk-free interest rate + Expected inflation rate + Maturity premium}$$ To this benchmark yield, we need to add the yield spread, the…
Credit of High Yield, Sovereign, and Non-sovereign Government Debt
Special considerations are important when evaluating the creditworthiness of debt issuers in 3 market segments: high-yield corporate bonds, sovereign bonds, and non-sovereign government bonds. High-yield (non-investment-grade or “junk”) corporate bonds are those rated below Baa3/BBB- by the major rating agencies….