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Sem 5 Prep
← Money & BankingMortgages, securitisation and the credit crisis

Formulas for this chapter

Loan-to-value ratio

LTV = Loan amount / Property value x 100 Loan = LTV x Property value Borrower's margin = Property value - Loan

Any mortgage sizing question. The LTV cap decides the loan; the remainder is the borrower's own contribution.

Loan amount
Sanctioned principal
Property value
Value of the collateral as assessed by the lender

Origination fee

Fee = fee rate x Loan amount

Whenever an origination fee is quoted. It applies to the loan, not to the property value.

fee rate
Quoted origination fee, usually a fraction of a per cent
Loan amount
Sanctioned principal, after the LTV cap

Tranche loss waterfall

Loss to a tranche = min(remaining loss, tranche size) Remaining loss passes up to the next tranche Senior tranche is safe until loss > total subordination

Allocating losses in a securitisation or CDO. Always work from the bottom slice upward, and compute total subordination to find the senior tranche's cushion.

tranche size
Face value of that slice of the securities
subordination
Total size of all slices below the one you are pricing

Leverage and the wipe-out point

Leverage L = Assets / Equity Critical asset fall = 1 / L Remaining equity = Equity - (fall % x Assets)

Any leveraged vehicle: an SIV, a margin position, a bank. At 10 to 15 times leverage a fall of 6.7% to 10% erases the equity.

Assets
Market value of what the vehicle holds
Equity
Own funds, the residual after debt

TED spread

TED spread = Interbank rate - Treasury bill yield (same tenor) 1 percentage point = 100 basis points

To measure credit risk in the banking system. Read both legs: a widening spread usually means interbank rates rising and bill yields falling as money runs to safety.

Interbank rate
Rate at which banks lend to each other, at the chosen tenor
Treasury bill yield
Government bill yield at the same tenor
Step 1 of 24
The ideaTheory

A loan you cannot sell, made into paper you can

A bank lends ₹50 lakh against a flat. That loan is now stuck on its books for twenty years.

Securitisation is the trick of bundling a thousand such loans and selling slices of the bundle to investors. The bank gets its money back today and lends again.

Done carefully, it is how a country builds a housing market. Done carelessly, with loans nobody checked and slices nobody understood, it is how 2008 happened. This chapter is both halves of that sentence.

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