Chapter 10, Problem 17P

To determine

Concept Introduction:

Bonds: It is a type of promise or contract to pay in the future with certain limitations and conditions specified at the time of issuing the bond.

Securitization: It is generally a type of pooling under which the loan taken by an individual is pooled and later on it is sold in the form of bonds.

Recession: Every economy has some business cycle. It is one of the business cycle in which there is an excess amount of goods supplied but the demand is very low. During a recession, unemployment is very high.

Answer to Problem 17P

a. Securitization

The process is called securitization. It leads to diversification and provide liquidity.

Explanation of Solution

• When Mae packages individual students’ loans into pools of loans and sells shares of these pools to investors, then this process is called securitization.

• The effects of securitization are that it helps in the greater diversification of portfolios for an investor comparative to the situation when they could only buy and sell individual student loans.

• It also provides liquidity as the bond is very flexible as it can be sold and bought any time.

b. Effects on the Accessibility of Loans

The ability of students to get loans will increase due to a fall in interest rates.

Mae action will have positive effect on the ability of students to get loans. This will certainly help students in getting loans at lower interest rates because investors are ready to provide funds for students as compared to the situation when there is only an individual loan available.

c. Loans during Recession

Recession adversely affects the availability of the loan and profit to investors during the time of recession.

• During severe recession, many graduating students become unemployed and default on their student loans. Default by many students led to a rise in interest rates on the bond in order to attract investors.

• Investors now believe that Mae bond is riskier than the earlier. It is because the interest rate has increased to attract them to buy the bond which makes the investor expect the same situation in the future and make them worse.

• The availability of the loan during recession would certainly decrease. During recession there is a huge unemployment due to which students will not be able to get jobs and repay their loans.