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Securitization

Securitization is the process of creating financial instruments by pooling various financial assets, which enhances market liquidity by allowing smaller investors to buy shares in larger asset pools. A common example is mortgage-backed securities, where mortgages are combined and sold in smaller, risk-tiered pieces to investors. This process benefits creditors by reducing their risk and allows investors to earn returns based on the underlying debt obligations, although it carries inherent risks related to asset value and borrower defaults.

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Alesandra Speca
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19 views1 page

Securitization

Securitization is the process of creating financial instruments by pooling various financial assets, which enhances market liquidity by allowing smaller investors to buy shares in larger asset pools. A common example is mortgage-backed securities, where mortgages are combined and sold in smaller, risk-tiered pieces to investors. This process benefits creditors by reducing their risk and allows investors to earn returns based on the underlying debt obligations, although it carries inherent risks related to asset value and borrower defaults.

Uploaded by

Alesandra Speca
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

What is 'Securitization'

Securitization is the process through which an issuer creates a financial instrument by


combining other financial assets and then marketing different tiers of the repackaged
instruments to investors, and this process can encompass any type of financial asset and
promotes liquidity in the marketplace.

Mortgage-backed securities are a perfect example of securitization. By combining mortgages


into one large pool, the issuer can divide the large pool into smaller pieces based on each
individual mortgage's inherent risk of default and then sell those smaller pieces to investors.

BREAKING DOWN 'Securitization'


The process creates liquidity by enabling smaller investors to purchase shares in a larger
asset pool. Using the mortgage-backed security example, individual retail investors are able
to purchase portions of a mortgage as a type of bond. Without the securitization of
mortgages, retail investors may not be able to afford to buy into a large pool of mortgages.

In securitization, the company holding the loans, also known as the originator, gathers the
data on the assets it would like to remove from its associated balance sheets. These assets
are then grouped together by factors such as time remaining on the loan, the level of risk, the
amount of remaining principle, and others.

This gathered group of assets, now considered a reference portfolio, is then sold to an
issuer. The issuer creates tradable securities representing a stake in the assets associated
with the portfolio, selling them to interested investors with a rate or return.

Benefits to Creditors and Investors


Securitization provides creditors with a mechanism to lower their associated risk through the
division of ownership of the debt obligations. The investors effectively take the position of
lender by buying into the security. This allows a creditor to remove the associated assets
from their balance sheets.

The investors earn a rate of return based on the associated principle and interest payments
being made by the included debtors on their obligation. Unlike some other investment
vehicles, these are backed by tangible goods. Should a debtor cease payments on his asset,
it can be seized and liquidated to compensate those holding an interest in the debt.

Securitization and Risk


Like other investments, the higher the risk, the higher potential rate of return. This correlates
with the higher interest rates less qualified borrowers are generally charged. Even though the
securities are back by tangible assets, there is no guarantee that the assets will maintain
their value should a debtor cease payment.

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