Qustion 1 only Read Attachment 3E “Goldman Sachs Hawks CDOs tainted by credit cr
ID: 2729242 • Letter: Q
Question
Qustion 1 only
Read Attachment 3E “Goldman Sachs Hawks CDOs tainted by credit crisis under new name These new products called Bespoke Tranche Opportunities (BTOs) allow investors to tailor the securitization however they want, but the two key dimensions are: (1) what credit risks are included in the pool of reference entities; and (2) how the deal is structured (tranched). Banks have learnt one thing since the crisis, and that is, unfunded issues can be very problematic, and so most of these deals appear to be fully funded. -Using the information in the article and any other information you may find about BTOs (HINT: do not waste too muchtime looking, there is not much as these are too new) to answer the following.- Consider the following different parties: the borrowing firms (F), the lenders who want credit protection (L), the "speculators" (S), the intermediary i.e. Goldman Sachs (GS). and the investors who buy BTOs (I). 1,' In any given deal of this nature we know that we need at least two of the above counterparties to take part, but of course, there can be many more than two. For the following three scenarios, please draw and label a diagram of the flow of funds, risk and return from the ultimate user of funds to the BTO investor: a,' Ethical Goldman Sachs creates BTOs to hedge insurance written for clients who have credit exposures to various firms.Explanation / Answer
Question 1
Question 1
1.(a) I (Investors)
GS (Goldman Sachs)
S (Speculators)
(b) GS (Goldman Sachs) L (Lenders)
1 (c) GS (Goldman Sachs) L (Lenders)
Question 2. (a) The following will be the step by step approach in finding out the 100 entities to be chosen. This is the criteria for selection.
In my own opinion, the following order of the six steps follows a logical thought process that makes it easier to pick a specific option for trading. These six steps can be memorized through a handy mnemonic – PROVES – which stands for Parameters, Risk/Reward, Objective, Volatility, Events, and Strategy.
A step-by-step guide to picking an option
Question 2 (b)
The financial leverage would be best suited for the above problem that’s because a leveraged finance is
Degree of Financial Leverage
The formula for calculating a company's degree of financial leverage (DFL) measures the percentage change in earnings per share over the percentage change in EBIT. DFL is the measure of the sensitivity of EPS to changes in EBIT as a result of changes in debt.
Formula:
DFL = percentage change in EPS or EBIT
percentage change in EBIT EBIT-interest
Question 2 (C)
Senior tranche : A senior tranche is the highest tranche of a security, i.e. the one deemed to be the least risky. Any losses on the value of the security shall be borne by the senior tranche only if all other tranches have lost all their value. For this safety, the senior tranche pays the lowest rate of interest.
The senior tranche may also be split into senior and super-senior tranches. Of the total value of a security the senior tranche is usually the largest, sometimes comprising up to 80% of the entire security.
What is 'Mezzanine Financing'
Mezzanine financing is a hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. Mezzanine financing is basically debt capital that gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies.
Since mezzanine financing is usually provided to the borrower very quickly with little due diligence on the part of the lender and little or no collateral on the part of the borrower, this type of financing is aggressively priced with the lender seeking a return in the 20-30% range.
RESIDUAL TRANCHE
A residual tranche is nothing but the "equity" portion of a CMO. The Tranche that receives what's left over after satisfying all other claims against the underlying cash flow is called as a residual tranche.
The above definitions and meanings point out clearly that the Senior tranche would best suit as it has a very less risk.
Question 2 (d) To Maximize the yield one has to choose Mezzanine financing.
Question2 (e) The Senior tranche would best suit as it has a very less risk.
Risk of financial leverage
Financial Risk
With debt, there is always risk. The cost of interest is never free, even when at their current low rates. These costs must be factored in when thinking about using leverage. If a company cannot repay the debt it will take on, it encounters the problem of defaulting on the loan and negatively affecting its credit score.
Bigger Losses
While a company’s profits will appear bigger with leverage, its losses will suffer the same fate. This is because the firm will have lost borrowed money. The fate of many businesses has been a disaster when careful planning and consideration were not given in plotting a new business enterprise or expansion.
Question 3 : The left over tranche could be re issued for other prospective buyers.
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