QUESTION 2

1. Securitization involves the pooling of groups of earning assets and removing those pooled assets from the lenders balance sheet. What advantages does securitization offer to the lending institutions? (4 marks)
2. National Bank placed a group of 10,000 consumer loans bearing an average expected gross annual yield of 6 percent in a package to be securitized. The investment bank advising National bank estimates that the securities will sell at a slight discount from par that results in a net interest cost to the issuer of 4.0 percent. Based on recent experience with similar types of loans, the bank expects 3 percent of the packaged loans to default without any recovery for the lender and has agreed to set aside a cash reserve to cover this anticipated loss. Underwriting and advisory services provided by the investment banking firm will cost 0.5 percent. National bank will also seek a liquidity facility, costing0.5percent, and a credit guarantee if actual loan defaults should exceed the expected loan default rate, costing 0.6 percent. Please calculate the residual income for National bank from this loan securitization. (4 marks)
3. What advantages do sales of loans have for lending institutions trying to raise funds? (2 marks)