Pay-Through Securities
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The African Development Bank (ADB) wants to securitize $500 million of its loans (with the weighted average interest rate of LIBOR plus 185 basis points) in the form of pay-through securities. Class A bonds account for 80% of the total bonds and they are assigned AA rating and sold at LIBOR plus 40 basis points. Class B bonds account for 15% of the total bonds and assigned BBB rating and sold at LIBOR plus 230 basis points. The rest, Class C bonds, are unrated and bought back by ADB. If we assume all the $500 million ADB loans are paid back fully by its borrowers in Africa, what would be the return for ADB on its Class C bond investment?
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Solution Summary
This solution contains brief calculations to compute the return for the different tranches of a securitized loan given that the group was fully paid are given. All steps and workings are shown.
Solution Preview
The trick is to figure how much is left to Class C after payment of the interests to Class A and Class B.
Total return = LIBOR + 185 bps
Weight of Class C = 100% ...
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