understanding the excess spread Typically in a structured product the AAA trans will be the largest tranche by far with 60 to 65 percent.

Followed by tranches below making up five to ten percent of the capital structure. Why is this it has to do with the transfer of cash flows from the asset pool to the investors and more importantly how that structure will create profits for the residual stakeholders.

Here, we have a 10% Equity stake the equity stake. Like all Equity Stakes also creates a buffer or cushion. If 10% of the loans go bad. There is still enough collateral to satisfy the debt holders in the various tranches. This is called over collateralization and is a key component of Structured Products. The loans in the asset pool will have a variety of ratings and interest spreads. If we wait those interest payments according to the size of the corresponding loans, we get a weighted average return or war in this example. We are assuming a three-month secured overnight financing rate of 0.12 percent if the weighted average returns spread is 350 basis points on those leverage loans, we would get an overall weighted average return of the total asset pool of 3.62% So that represents the cash coming in. What about the cash the fund owes to the investors? This is where the waitings of the trash is is critical in a typical structured credit product the Triple A tranche might receive sulfur plus 115.

the double A 175 the a 250 and the trip will be 325 the Double B 500 now these are illustrative suggestions. If we wait these payments by the size of the trash we can calculate the weighted average cost of liabilities.

In this case, it would be 1.57% the difference between the war and the weighted average cost of liabilities is the excess spread or profit that would flow to the equity holders.

We have to remember that the equity holders have invested 10% of the capital. So the 2.05% excess spread is calculated on all of the assets that are funded by the debt, which is 90% that leverage impact magnifies the return to equity holders by 10x.