Introduction to Structured Finance

FRANK J. FABOZZI, PHD, CFA, CFP, is an Adjunct Professor of Finance at Yale University's School of Management and the Editor of the Journal of Portfolio Management. HENRY A. DAVIS, MBA, is an editor, writer, and consultant working in the fields of banking and corporate finance. He currently serves as Editor of two quarterly professional journals, the Journal of Structured Finance and the Journal of Investment Compliance.MOORAD CHOUDHRY is Head of Treasury at KBC Financial Products in London. Previously, he worked at JPMorgan Chase Bank, where he was a vice president of structured finance services sales and marketing.

• Preface viiAbout the Authors xiiiCHAPTER 1 Introduction 1Definition of Structured Finance 1Other Definitions of Structured Finance 2Case Study: How Enron Has Affected the Boundaries of Structured Finance 15Conclusions 22CHAPTER 2 Interest Rate Derivatives 23Interest Rate Forward and Futures Contracts 23Futures Contracts 24Interest Rate Swaps 26Options 36Caps and Floors 43CHAPTER 3 Credit Derivatives 45Documentation and Credit Derivative Terms 45Credit Default Swaps 48Credit Default Swap Index 50Basket Default Swaps 51Asset Swaps 54Total Return Swaps 57Economics of a Total Return Swap 58CHAPTER 4 Basic Principles of Securitization 65What Is a Securitized Transaction? 66Illustration of a Securitization 67Reasons Why Entities Securitize Assets 70Benefits of Securitization to Investors 79What Rating Agencies Look at in Rating Asset-Backed Securities 79Description of the Collateral 82Prepayments Measures 87Defaults and Delinquencies 90CHAPTER 5 Securitization Structures 95Use of Interest Rate Derivatives in Securitization Transactions 95Credit Enhancement 104More Detailed Illustration of a Securitization 113CHAPTER 6 Cash Flow Collateralized Debt Obligations 119Family of CDOs 120Basic Structure of a Cash Flow CDO 122CDOs and Sponsor Motivation 124Compliance Tests 127CHAPTER 7 Synthetic Collateralized Debt Obligation Structures 133Motivations for Synthetic CDOs 134Mechanics 136Funding Mechanics 138Investor Risks in Synthetic Transactions 140Variations in Synthetic CDOs 141The Single-Tranche Synthetic CDO 147Summary of the Advantages of Synthetic Structures 149Factors to Consider in CDO Analysis 150Case Study 151CHAPTER 8 Securitized and Synthetic Funding Structures 155Commerical Paper 155Asset-Backed Commercial Paper 157Synthetic Funding Structures 162CHAPTER 9 Credit-Linked Notes 181Description of CLNs 181Illustration of a CLN 182Investor Motivation 182Settlement 182Forms of Credit Linking 184The First-to-Default Credit-Linked Note 190CHAPTER 10 Structured Notes 193Structured Notes Defined 194Motivation for Investors and Issuers 196Issuance Form and Issuers 197Creating Structured Notes 198Examples of Structured Notes 199CHAPTER 11 Large Ticket Leasing: Leasing Fundamentals 207How Leasing Works 207Types of Equipment Leases 208Full Payout Leases versus Operating Leases 211Reasons for Leasing 211Types of Lessors 216Lease Brokers and Financial Advisers 217Lease Programs 217Financial Reporting of Lease Transactions by Lessees 218Federal Income Tax Requirements for True Lease Transactions 222Synthetic Leases 224Valuing a Lease: The Lease or Borrow-to-Buy Decision 225CHAPTER 12 Leveraged Lease Fundamentals 237Parties to a Leveraged Lease 239Structure of a Leveraged Lease 243Closing the Transaction 245Cash Flows During the Lease 246Debt For Leveraged Leases 247Facility Leases 249Construction Financing 252Credit Exposure of Equity Participants 253Tax Indemnification for Future Changes in Tax Law 253Need for a Financial Adviser 254The Steps in Structuring, Negotiating, and Closing a Leveraged Lease 256CHAPTER 13 Project Financing 259What Is Project Financing? 260Reasons for Jointly Owned or Sponsored Projects 262Credit Exposures in a Project Financing 262Key Elements of a Successful Project Financing 264Causes for Project Failures 265Credit Impact Objective 277Accounting Considerations 279Meeting Internal Return Objectives 282Other Benefits of a Project Financing 282Tax Considerations 283Disincentives to Project Financing 283Recent Trends 284APPENDIX A The Basel II Framework and Securitization 287Basel Rules 288Impact on Securitization and Credit Derivatives 293APPENDIX B Synthetic Securitization: Case of Mortgage-Backed Securities 297Transaction Description 297Deal Structures 298Investor Considerations 301APPENDIX C Home Run! A Case Study of Financing the New Stadium for the St. Louis CardinalsCynthia A. Baker and J. Paul Forrester 303APPENDIX D Municipal Future-Flow Bonds in Mexico: Lessons for Emerging EconomiesJames Leigland 309APPENDIX E Crown Castle Towers LLC, Senior Secured Tower Revenue Notes, Series 2005-1Taimur Jamil 321APPENDIX F MVL FIlm Finance LLCOlga Filipenko 335APPENDIX G Presale: Honda Auto Receivables 2006-1 Owner TrustAmanda M. Soriano and Nadine E. Gunter 339APPENDIX H Presale: ACG Trust IIIAnthony Nocera, Ted Burbage, Philip Baggaley, and Michael K. Vernier 345APPENDIX I CNH Equipment Trust 2006-ADu Trieu, Bradley Sohl, Joseph S. Tuczak, and Peter Manofsky 355APPENDIX J CIT Equipment Collateral 2006-VT1Brigid E. Fitzgerald, John Bella, and Peter Manofsky 365Index 373

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.-- Riskbook.com