Sample Questions
Question 1
Easy
Mortgage REITs primarily generate income by:
Solution
D is correct.
Mortgage REITs (mREITs) invest in mortgage-backed securities or directly in mortgage loans. They typically use leverage to amplify the net interest margin, which is the spread between the yield earned on their mortgage assets and the cost of their short-term borrowings.
Mortgage REITs (mREITs) invest in mortgage-backed securities or directly in mortgage loans. They typically use leverage to amplify the net interest margin, which is the spread between the yield earned on their mortgage assets and the cost of their short-term borrowings.
Question 2
Medium
Milestone-based lending in venture debt most commonly involves:
Solution
D is correct.
Milestone-based lending structures the loan disbursement in tranches that are released as the borrower achieves specified milestones, such as revenue targets, product development goals, or securing additional equity funding. This reduces the lender's risk by ensuring capital is deployed only as the company demonstrates progress.
Milestone-based lending structures the loan disbursement in tranches that are released as the borrower achieves specified milestones, such as revenue targets, product development goals, or securing additional equity funding. This reduces the lender's risk by ensuring capital is deployed only as the company demonstrates progress.
Question 3
Hard
During the 2007-2008 financial crisis, model risk in CDOs was most severely exposed by:
Solution
D is correct.
The standard industry models used to price CDO tranches assumed that default dependence across the collateral pool followed a joint normal distribution. A joint normal dependence structure has thin tails, meaning it assigns very low probability to scenarios in which many assets default simultaneously. During the crisis, defaults clustered far beyond what these models predicted because real-world default dependence exhibits tail dependence (extreme co-movement during stress) that a joint normal assumption does not capture. This caused catastrophic losses in tranches that had been rated investment grade.
The standard industry models used to price CDO tranches assumed that default dependence across the collateral pool followed a joint normal distribution. A joint normal dependence structure has thin tails, meaning it assigns very low probability to scenarios in which many assets default simultaneously. During the crisis, defaults clustered far beyond what these models predicted because real-world default dependence exhibits tail dependence (extreme co-movement during stress) that a joint normal assumption does not capture. This caused catastrophic losses in tranches that had been rated investment grade.
