Question

a. Give some examples where a bank would use securitized instruments.

b. Describe an example where a bank could control their risk exposure to a counterparty or asset class using Securitized instruments such as CDS or MBS.

c. Why would a counterparty purchase these securities offered by the bank?

Answer 1

Securitization is the process of taking and illiquid asset,or a group of assets, and through financial engineering transforming it into a security.The derisive phrase " securitization food chain" popularised by the film inside job about 2007 2008 financial crisis describes the process by which groups of such assets are packed bought and securitized and sold to investors.

A typical example of securitization is a mortgage backed security creation of Larry fink at first Boston in 1983. It became extremely come by the mid of 1990.

A. The first mercantile Corporation served as vehicles of sovereign debt securitization for the British Empire during the late 17 century research from Christian universities show that Britain reconstructed its depth by offloading to eat to corporation with political banking which in turn sold shares back to those assets.

This process was so pervasive that might 1720 the South C Company in the East India company has really 80% of Crowns national debt . These corporations essentially became special purpose vehicles for the British treasury. Worry about the frailty of those corporate shares, however, led the British to stop securtizing and focus on a more conventional bond market.

B. The first step in the chase begins with a simple process of would be home or property owners applying for mortgage at commercial banks . Authorised financial institutes originates the loan which are secured by team against the various properties the mortgages purchase. Models notes are acids for the lenders but these assets come with clear counterparty risk. For example,if Joe agrees to lend funds to Mike up to a certain amount there is an expectation that Joe will provide the cash and Mike will pay those funds back there is still the counterparty risk assume by both parties .Mike my default on the loan and not payJoe back, or Joe might stop providing the agreed upon funds .

Financial investment product suggest stock option bonds and Bank investments and derivatives carry counterparty risk.

C. Risk involved in a transaction is counterparty risk which is the risk of a counterparty will be unable to fulfill his duties however many Financial Institutions the counterparties unknown counterparty with purchase sir securities offered by the bank because this leads to second big link in the chain individual mortgage abandoned together into mortgage full which is held in trust as Collateral for and mortgage backed security can be issued by third party financial company such as large investment banking form or by the same bank that originated the mortgage in the first place. A new security is created by the by playing against the mortgage of asset share of the securities can be sold to participate in the secondary mortgage market this market is extremely large providing a significant amount of liquidity to the group of mortgage which otherwise would be quite illiquid on their own. Ishwar will often choose to break the mortgage fund into a number of different parts the issuer open choose to grow the mortgage phone into a similar number of different parts referred to as tranches. The spreads the risk of default around similar to Houston it portfolio diversification works