Chartered Financial Analyst (CFA) Practice Exam Level 2

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Prepare for the CFA Exam Level 2 with comprehensive quizzes and resources. Test your knowledge with challenging questions that reflect the exam format and content. Build confidence and achieve your career goals in finance!

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How does overcollateralization affect a structured product?

It increases the default risk
It provides additional security to investors
It limits the interest yield
It enhances liquidity issues

The correct answer is: It provides additional security to investors

Overcollateralization refers to the practice of securing a structured product with collateral that is worth more than the underlying assets or liabilities. This mechanism inherently provides additional security to investors. By having a buffer of excess collateral, investors can be more assured that they will receive their scheduled payments, even if the performance of the underlying assets falters. In a structured product, overcollateralization can serve as a safeguard against potential defaults from the reference assets, ensuring that there are sufficient resources available to cover obligations to investors. This greater cushion not only mitigates risk but also fosters investor confidence in the security of their investment. Other options may refer to various aspects related to structured products, but they do not correctly represent the primary benefit of overcollateralization, which lies in the enhanced security it extends to investors.