1.

For sizing the credit enhancement required in an auto loan securitisation a credit rating agency,
after evaluating stress scenarios has specified the following multipliers of the expected loss to
achieve the required confidence levels (support) for each rating category:
AAA 5.00x
AA 4.00x
A 3.00x
BBB 2.00x
BB 1.75x

An asset pool has the following default and loss assumptions:

Default rate per annum 0.50%
Expected loss (base case) 1.68% Cumulative

Estimate the liability structure (size of each tranche) to provide adquate subordination support to
the senior and mezzanine tranches, if
Case 1: The proposed structure has tranches for all the categories from unrated to AAA
Case 2: The proposed structure has an unrated (equity) tranche, one mezzanine (BBB) tranche and
one senior (AAA) tranche

What would be the consequence if no mezzanine tranches are proposed?

Soln
Case 1
Required Size of
Rating Multiplier support liabilities
AAA 5.00x 8.40% 91.60%
AA 4.00x 6.72% 1.68%
A 3.00x 5.04% 1.68%
BBB 2.00x 3.36% 1.68%
BB 1.75x 2.94% 0.42%
Unrated 2.94% Residual/equity/first-loss piece

Case 2
Required Size of
Rating Multiplier support liabilities
AAA 5.00x 8.40% 91.600%
BBB 2.00x 3.36% 5.04%
Unrated 3.36%

If there is no mezzanine tranche, the size of the equity tranche would increae further to 8.4% in
order to support the senior (AAA) tranche. This is likely to reduce the return to the holder of the
equity tranche.
2a. Estimate the return for the equity tranche given the following structure
without considering any expected loss.
Tranche Par Value Coupon
Senior $ 60 mn 6.0%
Mezzanine $ 30 mn 10.0%
Equity $10 mn
Assume that the collateral is expected to earn a return of 10%. The fees
for intermediaries is 0.50%.
b. Re-estimate the return for equity tranche if the expected loss on the
collateral is 1.5%.

Soln
a
Par Value Rate Amount
Collateral 100 10% 10
less fees 0.50% 0.5
9.5
Tranche Interest
Senior 60 6.0% 3.6
Mezzanine 30 10.0% 3
Equity 10 2.9
Return for Equity Tranche 29.0%

b.
Expected Loss% 1.50%
Loss amount 1.5
Income of Equity (net of loss) 1.4
Equity Return 14%
3. Calculate the Overcollateralisation ratio (OC) and interest coverage ratio (IC) for
the CDO tranches described below
Rs crore Interest rate
AAA 24 8%
A 2 9%
BBB 1 10%
Unrated 3
Total 30

The total collateral is Rs 30 crore and earns an interest of 11% per annum.
Total fees are Rs 0.5 crore of which Rs 0.3 crore are paid on priority before interest on tranches.
Soln
Par Value Interest OC Ratio IC Ratio
Collateral 30 3.3

Fees 0.3
AAA 24 1.92 1.25 1.49
A 2 0.18 1.15 1.38
BBB 1 0.1 1.11 1.32
Unrated 3
4. An institution buys a credit default swap (CDS) on Entity X from a CDS seller for a notional
amount of Euro 1 million for 3 years. The swap premium is 100 basis points per annum paid
annually and the CDS contract stipulates cash settlement. What will be the exchange of
payments or instruments over the 3 years if Entity X defaults after 2.2 years and the bond of
Entity X trades at 20% of face value after the default? What would have been the terminal
exchange if the contract stipulated physical settlement instead of cash settlment?

Soln
Year 1: CDS Buyer (Institution) would pay Euro 10,000 to CDS Seller
Year 2: CDS Buyer (Institution) would pay Euro 10,000 to CDS Seller
Year 3: CDS Buyer (Institution) gets Euro 798,000 from CDS Seller after 2.2 years. (800,000 of
face value less recovery minus 2,000 pro rata premium for 0.2 years)
The contract is terminated after 2.2 years

If the contract stipulated physical settlement, the CDS Buyer would get Euro 998,000 from
CDS Seller and would deliver the underlying bond of Entity X to the CDS Seller.
6. An investment firm is structuring 100% principal protected equity-linked note for its
investors. The standard denomination of the note is Rs 1 lakh with a lot size of 10. The
note is zero coupon with a maturity of 3.5 years. The payoffs will be based on the value
of Nifty 50 index at the end of 3 years. payoffs are to be made after 3 years based on the
value of the Nifty 50 index at the end of 3 years. The targeted payoff to the investors are
as follows:
If Nifty level declines or does not increase: 0% Return
If Nifty level rises by upto 7.5%: 6.67x of Nifty Return
If Nifty level rises beyond 7.5%: 50% Return (Cap)

The investment firm can invest in bonds earning an yield of 10%, commensurate with
the credit rating of the note. The current Nifty value is 12,000. The current pricing of 3
year put and call options is as shown in the table below:
Put
Call Option
Option
10800 3050 130
11100 2840 160
11400 2630 210
11700 2430 260
12000 2230 320
12300 2050 390
12600 1880 470
12900 1730 560
13200 1580 660
13500 1410 770

Q1. How much amount will be invested in bonds?

Q2. Which options will be bought/sold & at what strike price?
Q3. How many options need to be bought & sold?
Q4. What is the fee the investment firm can earn?

Soln
1
Sale Proceeds from Investor 1,000,000

Fixed Income Investment

Fixed Redemption Value 1,000,000
Maturity of Note 3.50
Interest Rate on Fixed Income 10.00%
Fixed Income Investment 716,351

2
Since the payoff will increase with Nifty 50, above 12,000, at the money Nifty call options
(strike price = 12000) need to be bought. Since there is a cap when Nifty return is 7.50%,
i.e. at 12000 x (1+7.5%) = 12,900, the note will be structured with same number of short
positions in Nifty call options (strike price = 12,900). The premium on short positions will
partly fund the investment in long position in the call options.

3
Number of call options
Nifty Value 12,000
Strike Price of Long Call 12,000
Nifty Return for Cap 7.5%
Strike Price of Short Call 12,900
Participation Rate 6.67
Premium for call (K=12000), 3 Yr 2,230 Pay
Premium for call (K=12900), 3 Yr 1,730 Receive

For 1% Return on Nifty at Maturity 1.00%

Value of Nifty 12,120
% Increase for Investor 6.67%
Increase in Value for Investor 66,667

Payoff Per Long Call 120

No. of Long Calls Required 556
No. of Short Calls 556

4
Fees Earned
Investment in long calls 1,238,889
Premium earned on short calls 961,111

Total Investments (Fixed + Calls) 994,128

Fees earned 5,872

In % 0.59%
7. An investment firm is structuring an yield-enhancement equity-linked note for its
investors. The standard denomination of the note is Rs 1 lakh with a lot size of 10. The
note has a maturity of 3.75 years. The payoffs will be based on the value of Nifty 50 index
at the end of 3 years. payoffs are to be made after 3 years based on the value of the Nifty
50 index at the end of 3 years. The targeted payoff to the investors are as follows:
If Nifty level rises or does not decline: 60% Return
If Nifty level falls: 2x of Nifty decline (decay mutliple of 2x)

The investment firm can invest in bonds earning an yield of 12%, commensurate with the
credit rating of the note. The current Nifty value is 12,000. The current pricing of 3 year
put and call options is as shown in the table below:
Put
Call Option
Option
10800 3050 130
11100 2840 160
11400 2630 210
11700 2430 260
12000 2230 320
12300 2050 390
12600 1880 470
12900 1739 560
13200 1580 660
13500 1410 770

Q1. How much amount will be invested in bonds?

Q2. Which options will be bought/sold & at what strike price?
Q3. How many options need to be bought & sold?
Q4. What is the fee the investment firm can earn?

Soln
1
Sale Proceeds from Investor 1,000,000

Fixed Income Investment

Fixed Redemption Value 1,600,000
Maturity of Note 3.75
Interest Rate on Fixed Income 12.00%
Fixed Income Investment 1,046,050

2
Since the note loses value as Nifty 50 falls below 12,000, it can be structured using short
positions in Nifty put options. The premium on short position will fund part of the fixed
income investment to earn the enhanced coupon on the note.

3
Number of short Put Options
Nifty Value 12,000
Strike Price of Short Put 12,000
Premium on Short Put (K=12000), 3.5 Yr 320
For 1% Decrease in Nifty at Maturity -1.00%
Value of Nifty 11,880
% Decrease for Investor -2.00%
Change in Value for Investor (20,000)

Payoff Per Short Put (120)

No. of Short Puts 167

4
Fees Earned
Premium Earned on Short Puts 53,333

Total Investments (Fixed less Puts Prem 992,717

Fees earned 7,283

In % 0.73%
8. The following data pertains to a convertible bond
Par Value 1000
Coupon (annual) 5%
Frequency 2
Maturity 5
Yield for the bond's rating category 10%
Conversion Ratio 20
Stock Price at Issue 40

Current Convertible Price 850

Current Stock Price 36
Dividend Yield on Stock 1%

Estimate the following:

a. Bond Floor
b. Investment Premium
c. Parity or Conversion Value
d. Conversion Premium

How will the convertible bond be valued?

Soln
a. Bond Floor 806.96

b. Investment Premium
Convertible Price - Bond Floor 43.04
As % of Bond Floor 5.33%

c. Parity or Conversion Value

Conversion ratio x Current Stock Price 720

d. Conversion Premium
Convertible Price - Parity 130
As % of Parity Value 18.06%

The bond can be valued as the sum of the value of the bond and the value of the embedded option
(right to convert and sell the equity). The option component will be valued as a European option if
the right to convert is restricted to a single date or restricted period using Black Scholes. More
generally, it will be valued as an American option (for ex. using Binomial Tree method) since the
right to convert is available usually till maturity or issuer's call.
9. Bloomingdale Ltd. plans to acquire a commercial real estate property for Rs 50 crore at the beginning of 2020 with a target
the proposed financing arrangement, Nova Finance is ready to provide mezzanine finance up to 15% of the property value for
as cash coupon and 2% pay-in-kind). Under the arrangement, Nova Finance will also get an equity kicker upon the maturity of
gross rental income in excess of Rs Rs 12 crore, payable at the end of 5 years. Based on the alternative deal, National Bank is r
the property value for 5 years at the rate of 10%.

The management of Bloomingdale has projected gross rental income, total operating expenses and net operating income as fo
property value to appreciate to Rs 70 crore by the end of 2024. Taxes have been ignored.

Rs crore 2020 E 2021 E 2022 E 2023 E 2024 E

Gross rental income 12 12.6 13.2 13.9 14.6
Total operating expenses 7 7.4 7.8 8.2 8.6
Net operating income 5 5.2 5.4 5.7 6

Estimate the cash flows for National Bank, Nova Finance and Bloomingdale shareholders, based on the management projectio
ignoring all taxes.
Estimate the Cash-on-Cash Returns and IRR for each party.

Rs Crore Beg. 2020 2020 E 2021 E 2022 E 2023 E

NOI 5.00 5.20 5.40 5.70
Investment (50.00)
Net Cash Flow (50.00) 5.00 5.20 5.40 5.70
Senior Debt
Principal (35.00)
Interest 3.50 3.50 3.50 3.50
Cashflow: senior debt (35.00) 3.50 3.50 3.50 3.50
Mezzanine Finance
Accreted Value
Beginning value 7.50 7.50 7.65 7.80 7.96
Accrued PIK Interest@2% 0.15 0.15 0.16 0.16
End value 7.50 7.65 7.80 7.96 8.12
Cashflows
Principal (7.50)
Cash Interest@10% 0.75 0.77 0.78 0.80
PIK Interest Cashflow
Equity Kicker*
Cash flow: mezzanine (7.50) 0.75 0.77 0.78 0.80
Cash flow to Equity (7.50) 0.75 0.94 1.12 1.40

*Equity Kicker as per question = 30% x (0 + 0.6 + 1.2 + 1.9 + 2.6) = 1.89
 nning of 2020 with a target holding period of 5 years. Under
5% of the property value for 5 years at the rate of 12% (10%
kicker upon the maturity of the loan calculated as 30% of annual
ative deal, National Bank is ready to extend a loan of 70% of

d net operating income as follows. It also expects the

n the management projections, and as per the financing arrangement,

2024 E COC Returns IRR

6.00
70.00
76.00 1.95 16.5%

35.00
3.50
38.50 1.50 10.0%

8.12
0.16
8.28

7.50
0.81
0.78
1.89
10.98 1.88 15.6%
26.52 4.10 36.5%
Determine the debt-size for an oilfield development project based on the following assumptions. For simplicity, assume the fin
time value impact of the equity investment and debt drawdown schedule during construction period).
a. Estimate the key metrics under various debt % assumptions starting with base assumption of 60%, if the debt is amortised i
b. Suggest an optimal debt-size and repayment pattern based on debt sculpting

USD million
Project Cost 2400
Concession Period 39 years
Construction Period 5 years
Operations Period 34 years
Debt repayment period 22 yrs after COD
Min DSCR 1.80
Min Initial LLCR 2.00
Max Leverage 75%
Interest Rate 9.0%
COD = Date of commencement of operations

The estimated cashflow after tax, working capital and capex is estimated to be Rs 400 crore in the first 15 years of operations
over the next 19 years.

Soln
Step 1: Sources and Uses of Funds
Uses of Funds Debt Assumption
Project Cost 2400 Debt % 68%
Total Uses 2400 Key Metrics
Sources of Funds Min DSCR 1.81
Debt 1632 Initial LLCR 2.28
Equity 768 Project IRR 16.3%
Total Sources 2400 Equity IRR 26.4%

Step 2. CFADS
End of Construction Operational Phase
Year 5 6 7 8 9
Cashflow available for debt servicing 400.0 400.0 400.0 400.0

Step 3. Debt Amortisation Schedule

ai. Equal principal repayment Example. Do aii. Equal instalment yourself
Beginning Debt 1,632.0 1,557.8 1,483.6 1,409.5
Add: Interest 146.9 140.2 133.5 126.9
Less: Principal Repayment 74.2 74.2 74.2 74.2
Ending Debt 1,557.8 1,483.6 1,409.5 1,335.3
Total Debt Service = Repayment + Interest 221.1 214.4 207.7 201.0

Step 4. Waterfall
CFADS -2400 400.0 400.0 400.0 400.0
Debt Service -1632 221.1 214.4 207.7 201.0
Cashflow to Equity -768 178.9 185.6 192.3 199.0
Step 5. Key Metrics
DSCR 1.81 1.87 1.93 1.99

Debt % 68%
Min DSCR 1.81
Initial LLCR 2.28
Project IRR 16.3%
Equity IRR 26.4%
 For simplicity, assume the financing at the end of the construction period (ignoring the

0%, if the debt is amortised i. Based on equal principal repayments ii. Based on equal instalments.

e first 15 years of operations and are then expected to decline at the rate of 2% per annum

Debt Assumption
Debt % 60% 68%
Key Metrics
Min DSCR 2.05 1.81
Initial LLCR 2.58 2.28
Project IRR 16.3% 16.3%
Equity IRR 23.7% 26.4%

10 11 12 13 14 15 16 17 18 19
400.0 400.0 400.0 400.0 400.0 400.0 400.0 400.0 400.0 400.0

1,335.3 1,261.1 1,186.9 1,112.7 1,038.5 964.4 890.2 816.0 741.8 667.6
120.2 113.5 106.8 100.1 93.5 86.8 80.1 73.4 66.8 60.1
74.2 74.2 74.2 74.2 74.2 74.2 74.2 74.2 74.2 74.2
1,261.1 1,186.9 1,112.7 1,038.5 964.4 890.2 816.0 741.8 667.6 593.5
194.4 187.7 181.0 174.3 167.7 161.0 154.3 147.6 140.9 134.3

400.0 400.0 400.0 400.0 400.0 400.0 400.0 400.0 400.0 400.0
194.4 187.7 181.0 174.3 167.7 161.0 154.3 147.6 140.9 134.3
205.6 212.3 219.0 225.7 232.3 239.0 245.7 252.4 259.1 265.7
2.06 2.13 2.21 2.29 2.39 2.48 2.59 2.71 2.84 2.98
 20 21 22 23 24 25 26 27 28 29
400.0 388.0 376.4 365.1 354.1 343.5 333.2 323.2 313.5 304.1

593.5 519.3 445.1 370.9 296.7 222.5 148.4 74.2

53.4 46.7 40.1 33.4 26.7 20.0 13.4 6.7
74.2 74.2 74.2 74.2 74.2 74.2 74.2 74.2
519.3 445.1 370.9 296.7 222.5 148.4 74.2 0.0
127.6 120.9 114.2 107.6 100.9 94.2 87.5 80.9

400.0 388.0 376.4 365.1 354.1 343.5 333.2 323.2 313.5 304.1
127.6 120.9 114.2 107.6 100.9 94.2 87.5 80.9
272.4 267.1 262.1 257.5 253.2 249.3 245.7 242.3 313.5 304.1
3.13 3.21 3.29 3.39 3.51 3.65 3.81 4.00
 30 31 32 33 34 35 36 37 38 39
295.0 286.1 277.5 269.2 261.1 253.3 245.7 238.3 231.2 224.2

295.0 286.1 277.5 269.2 261.1 253.3 245.7 238.3 231.2 224.2

295.0 286.1 277.5 269.2 261.1 253.3 245.7 238.3 231.2 224.2
Determine the debt-size for an oilfield development project based on the following assumptions. For simplicity, assume the fin
time value impact of the equity investment and debt drawdown schedule during construction period).
a. Estimate the key metrics under various debt % assumptions starting with base assumption of 60%, if the debt is amortised i
b. Suggest an optimal debt-size and repayment pattern based on debt sculpting

USD million
Project Cost 2400
Concession Period 39 years
Construction Period 5 years
Operations Period 34 years
Debt repayment period 22 yrs after COD
Min DSCR 1.80
Min Initial LLCR 2.00
Max Leverage 75%
Interest Rate 9.0%
COD = Date of commencement of operations

The estimated cashflow after tax, working capital and capex is estimated to be Rs 400 crore in the first 15 years of operations
over the next 19 years.

Step 1: Sources and Uses of Funds

Uses of Funds Debt Assumption
Project Cost 2400 Debt % 60%
Total Uses 2400 Key Metrics
Sources of Funds Min DSCR 2.58
Debt 1440 Initial LLCR 2.58
Equity 960 Project IRR 16.3%
Total Sources 2400 Equity IRR 25.5%

Step 2. CFADS
End of Construction Operational Phase
Year 5 6 7 8 9
Cashflow available for debt servicing 400.0 400.0 400.0 400.0

Step 3. Debt Amortisation Schedule

b. Debt Sculpting Target DSCR 2.58 TRUE
Beginning Debt 1,440.0 1,414.6 1,386.8 1,356.6
Add: Interest 129.6 127.3 124.8 122.1
Less: Principal Repayment 25.4 27.7 30.2 32.9
Ending Debt 1,414.6 1,386.8 1,356.6 1,323.7
Total Debt Service = Repayment + Interest 155.0 155.0 155.0 155.0

Step 4. Waterfall
CFADS -2400 400.0 400.0 400.0 400.0
Debt Service -1440 155.0 155.0 155.0 155.0
Cashflow to Equity -960 245.0 245.0 245.0 245.0

Step 5. Key Metrics

DSCR 2.58 2.58 2.58 2.58

Debt % 60%
Min DSCR 2.58
Initial LLCR 2.58
Project IRR 16.3%
Equity IRR 25.5%
 For simplicity, assume the financing at the end of the construction period (ignoring the

0%, if the debt is amortised i. Based on equal principal repayments ii. Based on equal instalments.

e first 15 years of operations and are then expected to decline at the rate of 2% per annum

Debt Assumption
Debt % 60% 70%
Key Metrics
Min DSCR 2.58 2.21
Initial LLCR 2.58 2.21
Project IRR 16.3% 16.3%
Equity IRR 25.5% 30.4%

10 11 12 13 14 15 16 17 18 19
400.0 400.0 400.0 400.0 400.0 400.0 400.0 400.0 400.0 400.0

1,323.7 1,287.8 1,248.6 1,206.0 1,159.4 1,108.8 1,053.5 993.3 927.6 856.1
119.1 115.9 112.4 108.5 104.4 99.8 94.8 89.4 83.5 77.0
35.9 39.1 42.7 46.5 50.7 55.3 60.2 65.6 71.6 78.0
1,287.8 1,248.6 1,206.0 1,159.4 1,108.8 1,053.5 993.3 927.6 856.1 778.1
155.0 155.0 155.0 155.0 155.0 155.0 155.0 155.0 155.0 155.0

400.0 400.0 400.0 400.0 400.0 400.0 400.0 400.0 400.0 400.0
155.0 155.0 155.0 155.0 155.0 155.0 155.0 155.0 155.0 155.0
245.0 245.0 245.0 245.0 245.0 245.0 245.0 245.0 245.0 245.0
2.58 2.58 2.58 2.58 2.58 2.58 2.58 2.58 2.58 2.58
 20 21 22 23 24 25 26 27 28 29
400.0 388.0 376.4 365.1 354.1 343.5 333.2 323.2 313.5 304.1

778.1 693.1 605.1 513.7 418.4 318.8 214.4 104.5

70.0 62.4 54.5 46.2 37.7 28.7 19.3 9.4
85.0 88.0 91.4 95.3 99.6 104.4 109.9 104.5
693.1 605.1 513.7 418.4 318.8 214.4 104.5 0.0
155.0 150.4 145.9 141.5 137.3 133.1 129.1 113.9

400.0 388.0 376.4 365.1 354.1 343.5 333.2 323.2 313.5 304.1
155.0 150.4 145.9 141.5 137.3 133.1 129.1 113.9
245.0 237.6 230.5 223.6 216.9 210.4 204.0 209.3 313.5 304.1
2.58 2.58 2.58 2.58 2.58 2.58 2.58 2.84
 30 31 32 33 34 35 36 37 38 39
295.0 286.1 277.5 269.2 261.1 253.3 245.7 238.3 231.2 224.2

295.0 286.1 277.5 269.2 261.1 253.3 245.7 238.3 231.2 224.2

295.0 286.1 277.5 269.2 261.1 253.3 245.7 238.3 231.2 224.2