Financial Markets and Institutions,
2024 Release by Anthony Saunders
Complete Chapter Solutions Manual
are included (Ch 1 to 25)
** Immediate Download
** Swift Response
** All Chapters included
** Excel files included
,Table of Contents are given below
1. Introduction
2. Determinants of Interest Rates
3. Interest Rates and Security Valuation
4. The Federal Reserve System, Monetary Policy, and Interest Rates
5. Money Markets
6. Bond Markets
7. Mortgage Markets
8. Stock Markets
9. Foreign Exchange Markets
10. Derivative Securities Markets
11. Commercial Banks
12. Commercial Banks’ Financial Statements and Analysis
13. Regulation of Commercial Banks
14. Other Lending Institutions
15. Insurance Companies
16. Securities Firms and Investment Banks
17. Investment Companies
18. Pension Funds
19. Fintech Companies
20. Types of Risks Incurred by Financial Institutions
21. Managing Credit Risk on the Balance Sheet
22. Managing Liquidity Risk on the Balance Sheet
23. Managing Interest Rate Risk and Insolvency Risk on the Balance Sheet
24. Managing Risk off the Balance Sheet with Derivative Securities
25. Managing Risk off the Balance Sheet with Loan Sales and Securitization
,Solutions Manual organized in reverse order, with the last chapter
displayed first, to ensure that all chapters are included in this
document. (Complete Chapters included Ch25-1)
Answers to Chapter 25
Questions:
1. Loan securitization has increased in volume as a result of the creation of an active secondary market and the
implicit and explicit government guarantees on pass-through securities. The loan sales market has suffered from
credit risk exposure, high information and monitoring costs, and costly validation and transactions costs. Loan sales
have only been dominant in loan categories such as commercial and industrial loans that are too large and
heterogenous to package into securities.
2. Loans sold without recourse means that after selling the loan the originator of the loan can take it off the balance
sheet. In the event the loan is defaulted, the buyer of the loan has no recourse to the seller for any claims,
transferring the credit risk entirely to the buyer. For the originator, it has completely eliminated this loan from its
books. In the case of a sale with recourse, credit risk is still present for the originator because the buyer could
transfer ownership of the loan back to the originator. Thus, from the perspective of the buyer, loans with recourse
bear the least credit risk.
3. Short-term loan sales usually consist of maturities between one and three months and are secured by the assets of
a firm. They are usually sold in units of $1 million or more and are made to firms that have investment grade credit
ratings. Banks have originated and disposed of short-term loans as an effective substitute for commercial paper,
which have similar characteristics to short-term loans. The accessibility of commercial paper by more and more
corporations has reduced the volume of these short-term loans for loan sales purposes.
4. Commercial paper issuers are generally blue chip corporations that have the best credit ratings. Banks may sell
the loans of less creditworthy borrowers, thereby raising required yields. Indeed, since commercial paper issuers
tend to be well-known companies, information, monitoring, and credit assessment costs are lower for commercial
paper issues than for loan sales. Moreover, since there is an active secondary market in commercial paper, but not
for loan sales, the commercial paper buyer takes on less liquidity risk than does the buyer of a loan sale.
5. In a loan participation, the buyer does not obtain total control over the loan, while in an assignment, all rights are
transferred upon sale, thereby giving the buyer a direct claim on the borrower. Transactions costs are higher for loan
assignments than for loan participations since the loan must be transferred via a Uniform Commercial Code filing.
Moreover, current holders of the loan must be verified as well as any impediments to transfer, thereby further
increasing transactions costs upon loan sale under assignment. Monitoring incentives are higher and costs are lower
under loan assignments as opposed to loan participations. This is because the buyer is the sole holder of the loan and
thus there is no free-rider problem. Monitoring costs are lower since the loan assignment buyer need only monitor
the borrower's activities, while the loan participation buyer must monitor both the borrower and the originating
bank. Risk exposure is greater under loan participations than under loan assignments since participations have a
“double-risk” exposure. The buyer of the loan participation is exposed to the credit risk of the originating bank (still
controlling the loan) as well as the credit risk exposure of the borrower.
6. A highly leveraged transaction is a loan to finance an acquisition or merger. Often the purchase is a leverage
buyout with a resulting high leverage ratio for the borrower. U.S. federal bank regulators have adopted a definition
that identifies an HLT loan as one that (1) involves a buyout, acquisition, or recapitalization and (2) doubles the
company’s liabilities and results in a leverage ratio higher than 50 percent, results in a leverage ratio higher than 75
percent, or is designated as an HLT by a syndication agent.
7. The buyers of loans are:
i. Investment banks (since they are often involved with the initial transaction that leads to the issuance of the debt);
ii. Vulture funds (since they invest in portfolios of risky loans);
iii. Other domestic banks (in order to circumvent regional banking and branching restrictions so as to increase
regional and customer diversification);
iv. Foreign banks (to obtain a presence in the U.S. market without incurring the costs of a branch network);
v. Insurance companies and pension funds (to earn higher yields, when permissible);
1
, vi. Closed-end bank loan mutual funds (to earn fee income on loan syndications); and
vii. Non-financial corporations (to earn higher yields).
The sellers of loans are:
i. Major money center banks (to reduce capital requirements, diversify the loan portfolio, reduce reserve
requirements, and increase liquidity);
ii. Foreign banks (to reduce capital requirements, diversify the loan portfolio, reduce reserve requirements, and
increase liquidity);
iii. Investment banks (as market makers);
iv. Small regional or community banks; and
v. the U.S. government and its agencies.
8. The reasons for an increase in loan sales, apart from hedging credit risk, include:
(a) Removing loans from the balance sheet by sale without recourse reduces the amount of deposits necessary to
fund the FI, which in turn decreases the amount of regulatory reserve requirements that must be kept by the FI.
(b) Originating and selling loans is an important source of fee income for the FIs.
(c) One method to improve the capital ratio for an FI is to reduce assets. This approach often is less expensive than
increasing the amount of capital.
(d) The sale of FI loans to improve the liquidity of the FIs has expanded the loan sale market. This has made FI
loans even more liquid and reduced FI liquidity risk even farther. Thus, by creating the loan sales market, the
process of selling the loans has improved the liquidity of the asset for which the market was initially developed.
9. The three levels of taxes faced by FIs when making loans are; a) capital requirements on loans to protect against
default; b) reserve requirements on demand deposits for funding the loans; and c) deposit insurance to protect the
depositors. If the loans are securitized, FIs end up only servicing the loans. As a result, no capital is required to
protect against default risk. However, reserve requirements and deposit insurance will be reduced if liabilities are
also reduced. If the cash proceeds from the loan sales are used to invest in other assets, then the taxes will still
remain in place.
10. The sale or securitization of a loan converts a long term asset on the balance sheet into cash, thus reducing the
maturity and increasing the liquidity of the assets.
11. At the conclusion of the securitization process, the FI will have (1) exchanged a loan balance for cash, (2)
significantly reduced the maturity mismatch of its assets and liabilities, and (3) reduced the regulatory tax burden.
The risk profile is potentially reduced in two ways. First, exchanging loans for cash removes any risk-based capital
requirements for the FI. Second, if the cash is used to repay deposits, reserve requirements may be reduced.
12. Prepayment is the process of paying principal on a debt before the due date. In the case of an amortized loan
that has fixed periodic payments, prepayment means that the lender will receive fewer of the fixed periodic
payments, one or more payments of extra principal, and the final payment will be made before the final payment due
date. The two primary factors that cause prepayment are (1) the refinancing of the loan by the borrower because of
better interest rates and (2) the economic reality of having the cash to repay before maturity. In the case of
residential mortgages, this economic reality usually occurs with the sale of a house because of relocation. In the first
case, investors must reinvest at lower rates and thus realize lower rates of return over their entire investment
horizon. Housing turnover risk may or may not translate into losses for pass-through holders because interest rates
could remain the same, allowing them to reinvest the early payments in other instruments paying similar rates.
13. A CMO is a series of pass-through securities that have been allocated into different groups or tranches. Each
tranche typically has a different interest rate (coupon), and any prepayments on the entire CMO typically are
allocated to the tranche with the shortest maturity. Thus, prepayment risk does not affect the tranches with longer
lives until the earlier tranches have been retired. Many of the tranches in the CMO receive interest rates that are
lower than the average pass-through requirement because of the limited prepayment risk protection.
14. Mortgage backed bonds differ from collateralized mortgage obligation in two key ways. CMO help banks and
thrifts remove mortgages from their balance sheets, MBBs normally remain on the balance sheet. Also, CMOs have
2
