a. Is the investment vehicle a business? Justify your answer in no more than five (5) sentences. b. In no more than five (5) sentences, discuss how to determine who between the asset manager and debt investor has control over the investment vehicle.
An investment vehicle, the investee, is created and financed with a debt instrument held by a debt investor
and equity instruments held by some other investors. The equity tranche is designed to absorb the first
losses and to receive any residual return from the investee. One of the equity investors who hold 30% of
the equity is also the asset manager.
The investee uses its proceeds to purchase a portfolio of financial assets; thus, exposing them to the credit
risk associated with the possible default of principal and interest payments of the assets. The transaction is
marketed to the debt investor as an investment. Such investment has minimal exposure to the credit risk
associated with the possible default of the assets in the portfolio. It is because of the nature of the assets
and of the equity tranche.
The returns of the investee are significantly affected by the management of the investee’s asset portfolio.
Managing the asset portfolio includes decisions about the selection, acquisition, and disposal of the assets
within the portfolio guidelines. All those activities are the responsibilities of the asset manager. However,
when defaults reach a specified proportion of the portfolio value, a third-party trustee will now manage the
assets according to the instructions of the debt investor.
Managing the investee’s asset portfolio is the relevant activity of the investee. The asset manager can direct
the relevant activities until defaulted assets reach the specified proportion of the portfolio value; the debt
investor can direct the relevant activities when the value of defaulted assets surpasses that specified
proportion of the portfolio value.
Questions:
a. Is the investment vehicle a business? Justify your answer in no more than five (5) sentences.
b. In no more than five (5) sentences, discuss how to determine who between the asset manager and debt
investor has control over the investment vehicle.
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