Asset Securitizaton

Topics: Subprime mortgage crisis, Collateralized debt obligation, Investment Pages: 5 (2470 words) Published: October 21, 2014

125730022860000
FINC 3018
Bank Financial Management
Individual Assignment
Name: Duncan Oberg
SID: 310196302
Room: Storie Dixon 4 (N431)
Time: Thursday 5pm
Executive Summary
Asset securitization played a crucial role in the onset of the 2007-2008 sub-prime mortgage crisis, which inevitably aided in the creation of the worst economic conditions since the Great Depression. The nature and structure of securitized assets was not however what directly contributed to the Global Financial Crisis. These assets were reasonably new to the financial institutions and there was a limited understanding in pricing them. Along with this and record low interest rates, a profit motivated investor pool and increasing housing prices, securitized assets were at the forefront of the collapse of US and global markets in 2008. This report outlines the different types of asset securitization techniques, the risks involved in utilizing these mechanisms, impact that securitized assets had on the Global Financial Crisis of 2008 and the future of securitized. Types of Asset Securitization

Originally asset securitization was developed in the 1970’s as a result of government-sponsored programs to enhance the liquidity of the residential mortgage market. It involves the pooling of assets by financial institutions in order to reissue them to investors on the secondary market. Financial institutions utilize securitized assets in order to hedge their risks as well as increase liquidity, which leads to the freeing up of capital to further invest and loan. Underlying assets are removed from the balance sheet of the financial institution through the establishment of an entity called a Special Purpose Vehicle (SPV). As seen in figure 1 below, the SPV buys a pool of assets from the asset originator (financial institution) in order to sell to capital market investors on the secondary market. The SPV finances the initial purchase of assets by using a line of credit. Money raised from the issue is used to repay the credit and purchase more assets to securitize. The investors receive the income and repayment of the principal from the asset over the lifetime of the securities. The asset originator collects a service fee as it serves as a financial intermediary between the SPV and the investor. 800100107950Figure SEQ Figure \* ARABIC 1 - Asset Securitization 00Figure SEQ Figure \* ARABIC 1 - Asset Securitization

Pass-Through Securities
Pass-through securities are the most common form of securitized assets and are created from a pool of fixed income securities. As per the process outlined above, a financial institution removes the securities from the balance sheet and sells them to a SPV. The asset originator collects payments from issuers, collects a fee and passes them onto the investor as a coupon payment. A typical type of pass-through security is a mortgage-backed certificate whereby the homeowners mortgage payment passes on from the original bank through either a government agency or investment bank and onto investors. Collateralized Debt Obligations (CDO’s)

Collateralized debt obligations are sophisticated financial tools that banks use to repackage individual loans into a product that can be sold to investors on the secondary market. These packages consist of auto loans, credit card debt, mortgages or corporate debt. The term collateralized comes from the promised repayment being backed by the actual underlying asset in the loan. In general a CDO is a type of derivative. Banks began selling these derivatives to investors as they moved the loans risk of defaulting from the bank to the investor and it gave them a new and more profitable product to sell. Mortgage-Backed Bonds (MBB’s)

Unlike pass-throughs and collateralized debt obligations, mortgage backed bonds remain on the balance sheet of financial institutions and there is no direct link between the cash flow on mortgages and the payments on the bond. Financial institutions allocate...

References: Books
Lange et al, Financial intuitions management, McGraw-Hill Australia Pty Limited, 2013
Websites
Organization for Economic Co-operation and Development (2011), “Financial Market Trends”, Volume 2011 Issue 1,
http://www.oecd.org/finance/financial-markets/48620405.pdfBarnes, Ryan (2009) “The Fuel That Fed The Subprime Meltdown”, Investopedia
http://www.investopedia.com/articles/07/subprime-overview.aspRBA, Asset Securitization in Australia,
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