2. Read and summarize chapter 26 of your Financial Management text book in at least 400 words.

-Explain the concept of “reducing funding costs.”

– How important is credit when trying to obtain financing?

– Please complete questions #9,#10 and #12 of the chapter.

An  alternative  to  the  issuance  of  a  corporate  bond,  a  corporation
can  issue  a  security  backed  by  loans  or  receivables.  Securities  that
have  as  their  collateral  loans  or  receivables  are  referred  to  as  asset-
backed  securities.  The  transaction  in  which  asset-backed  securities  are
created  is  referred  to  as  a  structured  finance  transaction or structured
financing. In this chapter, we will explain what is meant by a structured
finance  transaction,  the  reasons  why  a  corporation  would  use  a  struc-
tured  finance  transaction  rather  than  issue  a  corporate  bond,  and  how
rating agencies assess the credit risk of a structured finance transaction.
While our focus in this chapter is on structured financing used by corpo-
rations,  it  should  be  noted  that  some  municipal  governments  use  this
form of financing rather than issuing municipal bonds and several Euro-
pean central governments use this form for financing.
WHAT IS A STRUCTURED FINANCE TRANSACTION?
The  term  “structured  finance”  refers  to  a  wide  variety  of  debt  and
related  securities.  The  key  element  of  structured  financing  is  that  the
obligation  of  the  issuer  to  repay  lenders  is  backed  by  the  value  of  a
financial asset or credit support provided by a third party to the transac-
tion.1 When we say the value of a “financial asset” we mean a loan, an
account receivable, or a note receivable. Keep in mind that a loan or a
1 Andrew A. Silver, “Rating Structured Securities,” Chapter 5 in Issuer Perspectives
on Securitization (New Hope, PA: Frank J. Fabozzi Associates, 1998), p. 5
A
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862 SELECTED TOPICS IN FINANCIAL MANAGEMENT
receivable  is  a  financial  asset  to  the  lender  but  a  liability  to  the  bor-
rower. So, in a structured financing, the lender is using a pool of loans
or receivables as collateral for debt instruments that it issues. To obtain
a  desired  credit  rating  sought  by  a  corporation  for  the  asset-backed
securities created by using a structured financing, both the value of the
financial assets and a third-party credit support may be needed.
In  Chapter  15  where  we  discuss  intermediate-  and  long-term  debt
instruments, we described secured debt instruments whose credit stand-
ing is supported by a lien on specific assets (i.e., a mortgage bond or col-
lateral trust bond) or by a third-party guarantee. However, with
traditional secured bonds, it is the ability of the issuer to generate suffi-
cient earnings to repay the debt obligation that is necessary for the issuer
to repay the debt. So, for example, if a manufacturer of farm equipment
issues a mortgage bond in which the bondholders have a first mortgage
lien on one of its plants, the ability of the manufacturer to generate cash
flow from all of its operations is required to pay off the bondholders.

9. Why  should  the  investor  in  an  asset-backed  security  be  concerned
with the capability of the servicer
10. What are the obligations that must be paid by the issuer of an asset-
backed security?
12. Why  doesn’t  an  issuer  of  an  asset-backed  security  seek  the  highest
credit rating of triple A?

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