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Introduction to Structured Finance

Introduction to Structured Finance

Frank J. Fabozzi, Henry A. Davis, Moorad Choudhry

ISBN: 978-0-470-10780-5

Jan 2007

400 pages



Created by the experienced author team of Frank Fabozzi, Henry Davis, and Moorad Choudhry, Introduction to Structured Finance examines the essential elements of this discipline. It is a convenient reference guide—which covers all the important transaction types in one place—and an excellent opportunity to enhance your understanding of finance.

Preface vii

About the Authors xiii

CHAPTER 1 Introduction 1

Definition of Structured Finance 1

Other Definitions of Structured Finance 2

Case Study: How Enron Has Affected the Boundaries of Structured Finance 15

Conclusions 22

CHAPTER 2 Interest Rate Derivatives 23

Interest Rate Forward and Futures Contracts 23

Futures Contracts 24

Interest Rate Swaps 26

Options 36

Caps and Floors 43

CHAPTER 3 Credit Derivatives 45

Documentation and Credit Derivative Terms 45

Credit Default Swaps 48

Credit Default Swap Index 50

Basket Default Swaps 51

Asset Swaps 54

Total Return Swaps 57

Economics of a Total Return Swap 58

CHAPTER 4 Basic Principles of Securitization 65

What Is a Securitized Transaction? 66

Illustration of a Securitization 67

Reasons Why Entities Securitize Assets 70

Benefits of Securitization to Investors 79

What Rating Agencies Look at in Rating Asset-Backed Securities 79

Description of the Collateral 82

Prepayments Measures 87

Defaults and Delinquencies 90

CHAPTER 5 Securitization Structures 95

Use of Interest Rate Derivatives in Securitization Transactions 95

Credit Enhancement 104

More Detailed Illustration of a Securitization 113

CHAPTER 6 Cash Flow Collateralized Debt Obligations 119

Family of CDOs 120

Basic Structure of a Cash Flow CDO 122

CDOs and Sponsor Motivation 124

Compliance Tests 127

CHAPTER 7 Synthetic Collateralized Debt Obligation Structures 133

Motivations for Synthetic CDOs 134

Mechanics 136

Funding Mechanics 138

Investor Risks in Synthetic Transactions 140

Variations in Synthetic CDOs 141

The Single-Tranche Synthetic CDO 147

Summary of the Advantages of Synthetic Structures 149

Factors to Consider in CDO Analysis 150

Case Study 151

CHAPTER 8 Securitized and Synthetic Funding Structures 155

Commerical Paper 155

Asset-Backed Commercial Paper 157

Synthetic Funding Structures 162

CHAPTER 9 Credit-Linked Notes 181

Description of CLNs 181

Illustration of a CLN 182

Investor Motivation 182

Settlement 182

Forms of Credit Linking 184

The First-to-Default Credit-Linked Note 190

CHAPTER 10 Structured Notes 193

Structured Notes Defined 194

Motivation for Investors and Issuers 196

Issuance Form and Issuers 197

Creating Structured Notes 198

Examples of Structured Notes 199

CHAPTER 11 Large Ticket Leasing: Leasing Fundamentals 207

How Leasing Works 207

Types of Equipment Leases 208

Full Payout Leases versus Operating Leases 211

Reasons for Leasing 211

Types of Lessors 216

Lease Brokers and Financial Advisers 217

Lease Programs 217

Financial Reporting of Lease Transactions by Lessees 218

Federal Income Tax Requirements for True Lease Transactions 222

Synthetic Leases 224

Valuing a Lease: The Lease or Borrow-to-Buy Decision 225

CHAPTER 12 Leveraged Lease Fundamentals 237

Parties to a Leveraged Lease 239

Structure of a Leveraged Lease 243

Closing the Transaction 245

Cash Flows During the Lease 246

Debt For Leveraged Leases 247

Facility Leases 249

Construction Financing 252

Credit Exposure of Equity Participants 253

Tax Indemnification for Future Changes in Tax Law 253

Need for a Financial Adviser 254

The Steps in Structuring, Negotiating, and Closing a Leveraged Lease 256

CHAPTER 13 Project Financing 259

What Is Project Financing? 260

Reasons for Jointly Owned or Sponsored Projects 262

Credit Exposures in a Project Financing 262

Key Elements of a Successful Project Financing 264

Causes for Project Failures 265

Credit Impact Objective 277

Accounting Considerations 279

Meeting Internal Return Objectives 282

Other Benefits of a Project Financing 282

Tax Considerations 283

Disincentives to Project Financing 283

Recent Trends 284

APPENDIX A The Basel II Framework and Securitization 287

Basel Rules 288

Impact on Securitization and Credit Derivatives 293

APPENDIX B Synthetic Securitization: Case of Mortgage-Backed Securities 297

Transaction Description 297

Deal Structures 298

Investor Considerations 301

APPENDIX C Home Run! A Case Study of Financing the New Stadium for the St. Louis Cardinals 303
Cynthia A. Baker and J. Paul Forrester

APPENDIX D Municipal Future-Flow Bonds in Mexico: Lessons for Emerging Economies 309
James Leigland

APPENDIX E Crown Castle Towers LLC, Senior Secured Tower Revenue Notes, Series 2005-1 321
Taimur Jamil

Olga Filipenko

APPENDIX G Presale: Honda Auto Receivables 2006-1 Owner Trust 339
Amanda M. Soriano and Nadine E. Gunter

APPENDIX H Presale: ACG Trust III 345
Anthony Nocera, Ted Burbage, Philip Baggaley, and Michael K. Vernier

APPENDIX I CNH Equipment Trust 2006-A 355
Du Trieu, Bradley Sohl, Joseph S. Tuczak, and Peter Manofsky

APPENDIX J CIT Equipment Collateral 2006-VT1 365
Brigid E. Fitzgerald, John Bella, and Peter Manofsky


Structured finance is one of those elusive terms that mean different things to different people. With this wonderful book, authors Fabozzi, Davis and Choudhry first explore the boundaries of what is and is not considered to be structured finance. A simple definition would be that structured finance is any form of non-traditional financing, but this begs the question of where to draw the line between traditional and non-traditional. Certainly, most people wouldn't consider a vanilla swap to be structured finance! Structured finance might be described in terms of techniques that are commonly employed—securitization, derivatives, special purpose vehicles (SPVs), leasing, project finance, etc. The authors explore this and other approaches to, if not defining structured finance, at least clarifying its boundaries.--