Series 7 practice questionmediumABS — Scenario — Credit Card ABS
A credit card asset-backed security enters its 'amortization period.' This means:
- ANew credit card receivables are being added to the pool
- BPrincipal payments from the underlying receivables are being passed through to investors rather than reinvested✓ Correct answer
- CThe credit card company is writing off bad debts
- DInterest rates on the underlying credit cards are being reduced
Explanation
Why B — Principal payments from the underlying receivables are being passed through to investors rather than reinvested
Credit card ABS typically have a revolving period during which principal payments are reinvested in new receivables, maintaining the pool size. When the amortization period begins (at a scheduled date or triggered by an early amortization event), principal payments are passed through to investors to pay down the securities. Early amortization can be triggered by deteriorating pool performance, the seller's bankruptcy, or the excess spread falling below a specified threshold.
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