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Student: Terry Donnell McKinney

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FIN-7013 Dr. Riyad Abubaker

Investment Portfolio Analysis Week 1 - Assignment: Evaluate Financial

Markets, Securities, and Institutions Along
with Associated Risks

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McKinneyT_FIN7013-1

Week 1 - Assignment: Evaluate Financial Markets, Securities, and Institutions Along with

Associated Risks

FIN-7013 Investment Portfolio Analysis Week 1 Assignment 1

Terry D. McKinney

Dr. Riyad Abubaker

August 25, 2019

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Abstract

Financial engineering has been disparaged as nothing more than paper shuffling. Critics

argue that resources used for rearranging wealth (that is, bundling and unbundling financial

assets) might be better spent on creating wealth (that is, creating real assets). This paper

evaluates this criticism, and discusses any benefits realized by creating an array of derivative

securities from various primary securities. The paper will also discuss why you would expect

securitization to take place only in highly developed capital markets. Finally. The paper will

touch on the relationship between securitization and the role of financial intermediaries in the

economy, and the end results to financial intermediaries as securitization progresses.

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Introduction

The managers of public firms are drawn to developmental transaction or financial

interpretation of accounting standards, to present management’s earnings, balance sheet, and

cash flow requirements, though it may possible circumvent the true meaning of standard setters

by way of accounting-motivated financial engineering. When standard setters doctor up

predominant standards to combat prepared financial engineered predictions, it starts a turnabout

reaction for preparers of financial engineering reports to respond, causing a back and forth game

effect[ CITATION Dye15 \l 1033 ].

As such, financial engineering has been disparaged as nothing more than paper shuffling.

Critics argue that resources used for rearranging wealth (that is, bundling and unbundling

financial assets) might be better spent on creating wealth (that is, creating real assets). This paper

evaluates this criticism, and discusses any benefits realized by creating an array of derivative

securities from various primary securities. The paper will also discuss why you would expect

securitization to take place only in highly developed capital markets. Finally. The paper will

touch on the relationship between securitization and the role of financial intermediaries in the

economy, and the end results to financial intermediaries as securitization progresses.

What is Financial Engineering

Financial engineering incorporates the use of mathematical concepts as means to

determine solutions to financial situations. Financial engineering includes resources from the

areas of computer science, statistics, economics, and applied mathematics to address present

financial issues, in addition to development of new and innovative products. Often referred to as

quantitative analysis, financial engineering is a commonly used resource of commercial banks,

investment banks, insurance agencies, and hedge funds[CITATION Tuo19 \l 1033 ].

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Financial industries constantly search for ways to establish and innovate investment tools

and products to be used by their investors and companies. Most of these products are developed

through methods in the area of financial engineering. By using mathematical modeling and

computer engineering, financial engineers can exam and present newer tools and resources to

perform investment analysis, debt offerings, new investments, new trading strategies, new

financial modeling, and so forth.

In a nutshell, financial engineers operate quantitative risk models that predict how

investment tools will perform and whether a new offering in the financial sector would result in

long-term viability and profitability, as well as the specific types risk possibilities for each

product offering with regards to the volatility of the markets. Financial engineers I mostly found

to be working a proprietary trading, risk management, portfolio management Camera

microfinance departments from within the companies they work for.

Criticism of financial engineering

Financial engineering revolutionized financial markets as it played a major role in the

2008 financial crisis. While numerous defaults in subprime mortgage payments increased, an

increase in credit events was also triggered. financial institutions we're unable to make payments

on these swaps as the default regarding the situations were happening nearly simultaneously. As

a result, corporate buyers that had invested in mortgage backed securities would realize they

would become worthless. These encouraged losses We give them the excuse to reduce the value

of assets on their balance sheets, which will lead to additional failures from a corporate

standpoint , any subsequent economic recession [CITATION Tuo19 \l 1033 ]. Because the 2008

global recession brought on by engineered structured products, Financial engineering is often

regarded as a controversial field subject. Nonetheless, it goes without saying that this
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quantitative study just made great improvements in the financial markets and processes by

establishing innovation, rigor, and efficiency to the markets.

Securitization

Securitization is the process that issues used to design a marketable financial estimate by

combining various financial assets into one group. The issuer later sales the grouped packaging

has access to investors. Securitization creates opportunities for investors while freeing up capital

for originators[ CITATION Buc17 \l 1033 ]. The results of these outcomes promote liquidly in the

marketplace. Theoretically, all financial assets can be securitized, or turn it into something that is

a tradable item of monetary value. Securitization mostly occurs with its other various assets that

produce receivables of consumer commercial debt, it can also incorporate the pulling of

contractual debts.

The securitization process establishes the quiddity by providing a means for investors to

purchase or acquire shares in areas that would normally be unavailable to. A securitized zone-

based investment is substantiated or backed by tangible goods. Therefore, if a debtor as to

suddenly stop making payments, the asset for which the loan was made can be seized and

liquidated to compensate those hold interest in that, which would be the investors.

However, though these types of securities are backed by 10 to assets, there’s no guarantee

the value of the assets will hold, meaning they could increase or decrease in market value.

Securitization allows creditors a mechanism to reduce the Association of risk by dividing down a

shift of the debt obligations. Various securities can hold various levels of risk depending on the

investor yield amounts. Investors should therefore understand that the debt underlying the

product they are acquiring.

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Securitization in highly developed capital markets

It would be expected for securitization to take place more commonly in highly developed

capital markets. Realistically, securitization demands accessibility to a very large possibility of

investors. With regards to capital markets, investors are seemingly drawn to it because it

provides a safe system of business laws while also providing a low probability of confiscatory

taxation and regulation. Also, capital markets require a strongly developed investment banking

industry, as well as a substantiated establish system of brokerage financial transactions. Lastly,

capital markets provide a very well-established media structure that sitters particularly around

financial reporting. To characteristics of these capital markets that result in a very financial

market is the main reason that you would expect securitization to focus only on this type of

market.

Investment firms can raise capital from investors by issuing shares primary markets.

Regardless of whether a firm issue stock to a certain year, the stock market is still important to

investors.

The relationship among securitization and the role of financial intermediaries economically

Ultimately securitization propels into disintermediation being that it provides an outlet

for investors that are participating in the market or jump over intermediaries. Just as mortgage-

backed securities could channel funds into the housing market without expecting financial

institutions to provide alarms from their portfolios. As such, with securitization increases or

moves forward, the financial intermediaries also move forward or increase in other areas or

activities such as short-term liquidation to customers in small businesses and financial services.

Financial assets allow an easy path for large firms to create capital that can be used to

finance their investments in real assets. In other words, Samsung could easily raise their capital if
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need be because they can issue stocks to the general public. If Samsung or any other company

were unable to issue stocks or pasta the general public, they would have a difficult time

obtaining capital. Contraction of the supply of financial assets would complicate the ability to

finance, and as a result in increased the cost of capital. When the cost of capital is higher, it

results in a reduction in investment and real growth.

Truthfully speaking, the well-being of the economy can be determined by real assets.

Individuals and firms ultimately benefit from financial engineering when it results in establishing

new products that allowed them to manage portfolios of financial assets more accurately. The

creation of various financial resources and incorporate new properties sensitivities to a wide

array of risk, allow investors to take on sources of risk more efficiently.

Securitization and financial intermediation

The implications of securitization can be related to the process of financial intermediation

just been performed by commercial banks and others. Financial intermediaries watch over the

process of funds from savers to borrowers. This is done by establishing liability and asset

instruments that equally satisfy the various needs of lenders and borrowers. Financial

intermediaries^$investment savers with large investment borrowers and establish long-term

loans to borrowers using funds provided by short-term deposits of savers. As financial

intermediaries loan out the positive funds in this matter, savers benefit from the reduction in

credit risk that what they would normally be exposed to.

Though financial intermediaries originate securitized assets, securitization establishes a

specific obligation among specific borrowers and specific lenders. Securitization extends

depending on the economic goals of savers and borrowers as per their achievements in this

process as opposed to going through financial intermediaries. Presently, active financial futures
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and options markets allow savers to directly purchase their desired degree of protection from

interest rate risk as specified markets. Additionally, future forms allowing individual saver to

purchase somewhat small investment amounts of diversified interest in debt securities. These

developments provide the possibility for savers and borrowers to satisfy the diverse needs by

eliminating the need to employ financial intermediaries in the traditional sense[ CITATION Poz16 \l

1033 ].