Question

1. Explain securitization.

Answer 1

Securitization is the practice of taking an illiquid asset or a group of financial assets/debt and, and transforming it (or them) through financial engineering to sell the related cash flows to third party investors as securities (e.g., bonds, pass-through securities, or collateralized debt obligations (CDOs)). Investors are repaid from principal & interest cash flows collected from underlying debt & redistributed through capital structure of new financing. Securities which are backed by mortgage receivables are known as mortgage-backed securities (MBS), whereas those which are backed by other types of receivables are called asset-backed securities (ABS). An example of securitization is mortgage-backed security (MBS), type of asset-backed security secured by a collection of mortgages. The example of assets/debt which undergo securitization are residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which generate receivables).