Question

write a short essay by using the following words

securitization

asset- backed security

mezzanine tranche

CDO

subprime mortatge

flight to quality

rating and bubble

Answer 1

a)Securitization:It is a process by which a company clubs its different financial assets/debts to form a consolidated financial instruments which is issued to investors.In return,the investors in such securities get interest.

This process enhance liquidity in the market.This serves as a useful tool,especially for financial companies,as its helps them raise funds.If such a company has already issued a large number of loans to its customers and wants to further add to the number,then the practice of securitiation can come to its rescue.

b)Asset- backed security:Asset backed securities are pools of loans that are packeged and sold to investors as securities.The type of loan that are typically securitized includes home mortgage,credit card receivable,auto loans,home equity loans,student loans and loans for boats.

When a consumer takes out a loan,their debt becomes an asset on the balance sheet of the lender.In turn,the lender can sell these assets to a trust or special purpose vehicle, which packages them into asset-backed security that can be sold in the public market.

c)Mezzanine tranche:A mezzanine tranche is a small layer positioned between the senior tranche(mostly AAA) and a junior tranche(Unrated,typically called equity tranche).The mezzanine tranche,is normally defined as the price above an investment grade rating-that is,if the transaction was putatively to be rated BBB,what would have been the support required.

d)CDO:A collateralized debt obligation(COD) is a type of structured asset backed security.Originally developed as instruments for the corporate debt markets,after 2002,COD became vehicle for refinancing mortgage backed securities.Like other private label securities backed assets,a COD can be thought of as a promise to pay investors in a prescribed sequence,based on the cash flow the COD collects from the pool of bonds or other assets its own.

e)Subprime mortatge:A subprime mortgage is one that's normally issued to borrowers with low credit ratings.Lending institutions often charge interest on subprime mortgage at a much higher rate than on prime mortgage to compensate for carrying more risk.These are often adjustable-rate mortgage as well,so interest rate can potentially increase at specified points in time.

f)Flight to quality:It is a market phenomenon occuring when investors sell what they perceive to be higher risk investments and purchase safer investments,such as gold and other precious metals.This is considered a sign of fear in the market place,as investors seek less risk in exchange for lower profits.Flight to quality is usually accompanied by an imcrease in demand for assets that are government backed and a decline in demand for assets backed by private agents.