Securitisation and Derivatives
This domain covers pooling and true sale of receivables, and the pricing and hedging of forwards, futures, options and swaps. The exam favours structure described in words plus no-arbitrage checks.
Securitisation
An originator sells a diversified pool to a bankruptcy-remote SPV in a true sale, funded by issued securities. Credit enhancement comes from subordination/tranching (senior, mezzanine, equity), over-collateralisation, cash reserves and guarantees. Borrower cash flows pass to investors after servicing fees; prepayment risk generally sits with investors unless the structure has a revolving period.
Derivatives
Forward price F = S(1 + r)^T (cost of carry); futures are marked to market daily with initial and variation margin. Call payoff = max(ST − K, 0); put payoff = max(K − ST, 0); premium is paid upfront by the buyer. European put–call parity without dividends: C + PV(K) = P + S. An interest rate swap is valued as the difference between a fixed-rate and a floating-rate bond leg.
Worked example
S = ₹480, K = ₹500, r = 10% p.a., six months, C = ₹22. PV(K) = 500/1.05 = ₹476.19. Parity gives P = C + PV(K) − S = 22 + 476.19 − 480 = ₹18.19. The market put is ₹20, so sell the put, buy the call, short the stock and invest ₹476.19: inflow = 20 − 22 + 480 = ₹478, compounding to ₹501.90 against the ₹500 obligation - a riskless ₹1.90.
Traps
Calling a secured loan a securitisation (no true sale, no SPV); ignoring servicing and enhancement costs when quoting investor yield; assuming option buyers post margin; applying put–call parity to dividend-paying stocks or American options without adjustment; confusing forwards with futures on mark-to-market cash flow.