72. Which of the following is NOT true of an R class CMO issue?

A. It is treated as "garbage class."

B. It is a high-risk investment class.
C. It gives the investor the rights to the over-collateralization and reinvestment income on the
cash flows in the CMO trust.
D. Returns increase when interest rates increase.
E. It has a positive duration.

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Learning Objective: 26-02 Discuss and provide examples of the three major forms of asset securitization.
Saunders - Chapter 26 #72

73. Why do garbage class bonds often have a negative duration?

A. The value of the returns in this bond class increases when interest rates increase.
B. It gives the rights to collateralization.
C. Bond values fall with interest rate increases.
D. It gives rights to reinvestment income on the cash flows in the CMO trust.
E. Significant risk premium required by the uninsured depositors.

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Learning Objective: 26-02 Discuss and provide examples of the three major forms of asset securitization.
Saunders - Chapter 26 #73
74. An FI operating in the United States funds a US$5 million residential mortgage in 2014 by
allocating capital and by issuing demand deposits. The mortgage represents a loan-to-value of
70 percent. The demand deposits have a reserve requirement of 10 percent and a deposit
insurance premium to FDIC of 23 basis points.

What is the minimum capital requirement on the mortgage in order for the institution to be
adequately capitalized?

A. $0.
B. $400,000.
C. $200,000.
D. $500,000.
E. $5,000,000.

Refer to Chapter 20: Capital Adequacy

With a loan-to-value of 70%, the mortgage falls into mortgage risk category 1 and carries a
risk weight of 50 percent. In order to be adequately capitalized the bank must have a total risk-
based capital ratio of 8%.
Capital requirement = $5,000,000 × 0.50 × 0.08 = $200,000

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Learning Objective: 26-03 Discuss the benefits and costs of securitization for an FI.
Saunders - Chapter 26 #74
75. An FI operating in the United States funds a US$5 million residential mortgage in 2014 by
allocating capital and by issuing demand deposits. The mortgage represents a loan-to-value of
70 percent. The demand deposits have a reserve requirement of 10 percent and a deposit
insurance premium to FDIC of 23 basis points.

What amount of demand deposits are needed to fund the mortgage?

A. $5,500,000.
B. $400,000.
C. $5,555,555.
D. $500,000.
E. $5,000,000.

Refer to Chapter 19: Deposit Insurance and Other Liability Guarantees

Minimum demand deposits to fund $5,000,000 mortgage and also to fund required reserves.
Demand deposits = loan amount ÷ (1 - reserve ratio)
DD = 5,000,000 ÷ (1 - 0.10) = 5,000,000 ÷ 0.90 = $5,555,555

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Learning Objective: 26-03 Discuss the benefits and costs of securitization for an FI.
Saunders - Chapter 26 #75
76. An FI operating in the United States funds a US$5 million residential mortgage in 2014 by
allocating capital and by issuing demand deposits. The mortgage represents a loan-to-value of
70 percent. The demand deposits have a reserve requirement of 10 percent and a deposit
insurance premium to FDIC of 23 basis points.

What is the deposit insurance premium on the demand deposits issued to fund the mortgage?

A. $11,756.
B. $12,778.
C. $11,500.
D. $1,150.
E. $9,200.

Deposit insurance premium is 23 basis points

$5,555,555 × 0.0023 = $12,777.77

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Learning Objective: 26-03 Discuss the benefits and costs of securitization for an FI.
Saunders - Chapter 26 #76
 77. An FI operating in the United States funds a US$5 million residential mortgage in 2014 by
allocating capital and by issuing demand deposits. The mortgage represents a loan-to-value of
70 percent. The demand deposits have a reserve requirement of 10 percent and a deposit
insurance premium to FDIC of 23 basis points.

What would have been the capital requirements if the FI had securitized the mortgage?

A. $0.
B. $400,000.
C. $200,000.
D. $500,000.
E. $5,000,000.

If the mortgage was immediately securitized and removed from the balance sheet, there would
be no capital requirements necessary.

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Learning Objective: 26-03 Discuss the benefits and costs of securitization for an FI.
Saunders - Chapter 26 #77

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