LO 36.4: Describe the credit ratings process with respect to subprime mortgage backed securities.
A credit rating is defined as an opinion on the creditworthiness of the specific bond issue. Note that the assigned rating is specific to the security and in no way a reflection on the originator. The ratings represent an unconditional view of the rating agency as they rate through-the-cycle.
The rating process involves two steps: (1) estimation of loss distribution and (2) simulation of the cash flows. Once the estimates are obtained, the agency indicates the level of credit enhancement necessary to achieve the desired rating. If the projected rating is too low, the originator can provide additional enhancement to raise the rating.
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