- CFA Exams
- CFA Level I Exam
- Topic 6. Fixed Income
- Learning Module 18. Asset-Backed Security (ABS) Instrument and Market Features
- Subject 2. ABS Structures to Address Credit Risk
CFA Practice Question
Which of the following is a form of external credit enhancement?
II. Bond insurance
III. A corporate guarantee
IV. A letter of credit
I. A bond "wrap"
II. Bond insurance
III. A corporate guarantee
IV. A letter of credit
Correct Answer: I, II, III and IV
These are all forms of external credit enhancement.
There are two general types of credit enhancement: internal and external. External credit enhancement usually comes in the form of bond insurance, a letter of credit, or a corporate guarantee. Internal credit enhancements are typically employed in a more complicated form, and include reserve funds, over collateralization, and the senior/subordinate structure of debt securities.
When a debt security has the backing of an insurer, the bond is said to possess an insurance "wrap." This is a common term in the market for debt securities, and one with which you should become familiar.
User Contributed Comments 3
| User | Comment |
|---|---|
| kalps | 'Wrap' refers to insurance |
| DariSH | So, I and II are actually the same |
| Roman91 | DariSH, I and II are not exactly the same. Insurer can default just as much as issuer of debt security; therefore, there is SOMEONE out there who will guarantee that insurer will pay you in the case if issuer defaults. So WRAP essentially refers to an additional layer of protection for debt holder. |