Understanding the Model
Each individual chapter has focused on explaining one concept of a structured finance model and the mechanics behind implementing that concept in Excel. At this point, the model is mechanically complete and many individual sections have been covered. However, the ability to integrate assumptions into interconnected concepts and produce interpretable results is where the true value of a financial model resides.
So, what happens when asset losses increase? Will the senior bonds receive all of the scheduled interest and principal? What stress scenarios can the transaction handle? All of these questions require an understanding of how each individual component of the model works and how all of those elements work together as a whole.
The best method of understanding a model is by changing individual assumptions one by one and evaluating the results. This allows a model operator to witness the cause and effect of each assumption. It is particularly valuable to set the assumptions to reasonable extremes so that result differences are more evident. This section first reviews the model as a whole and then walks through the results of changing each of the major assumptions.
THE COMPLETE MODEL IN REVIEW
A top-down approach separates the model into two distinct sections: assets and liabilities. On the asset side, cash is generated over time by yield, scheduled amortization, voluntary prepayments, and default recoveries. All of these methods of cash flow ...