Section B – TWO questions ONLY to be attempted The finance division of GoSlo Motor Corporation has made a number of loans to customers with a current pool value of $200 million. The loans have an average term to maturity of four years. The loans generate a steady income to the business of 10·5% per annum. The company will use 95% of the loan’s pool as collateral for a collateralised loan obligation structured as follows: – 80% of the collateral value to support a tranche of A-rated floating rate loan notes offering investors LIBOR plus 140 basis points. – 10% of the collateral value to support a tranche of B-rated fixed rate loan notes offering investors 11%. – 10% of the collateral value to support a tranche as subordinated certificates (unrated). In order to minimise interest rate risk, the company has decided to enter into a fixed for variable rate swap on the A-rated floating rate notes exchanging LIBOR for 8·5%. Service charges of $240,000 per annum will be charged for administering the income receivable from the loans. You may ignore prepayment risk. Required: (a) Calculate the expected returns of the investments in each of the three tranches described above. Estimate the sensitivity of the subordinated certificates to a reduction of 1% in the returns generated by the pool. (10 marks) (b) Explain the purpose and the methods of credit enhancement that can be employed on a securitisation such as this scheme. (4 marks) (c) Discuss the risks inherent to the investors in a scheme such as this. (6 marks)