Structured finance is a term that has a broad set of details describing the financial sector created to aid risk transfer using complex legal entities and corporations. This risk transfer to apply for securitization of various financial assets (eg mortgages, credit card receivables, car loans, etc.) helps open up new sources of financing to consumers. However, that arguably led to a degradation in underwriting standards for these financial assets, which helped to create the mid-2000s credit bubble and the 2007-2009 credit crash and financial crisis.
Securitization is a method used by structured financial participants to create a pool of assets that are used in the creation of final product financial instruments.
Tranching is a system used to create different investment classes for securities created in the world of structured finance, which is why it is an important concept in structured finance. Tranching allows cash flows from the underlying asset to be transferred to different groups of investors.
Credit enhancement is key in creating security with a higher rating than the issuing company. Issuance of subordinate bonds is the average for creating credit increases. Subordinate bonds are allocated losses from collateral before losses are allocated to Senior Bonds, thus giving senior bonds an increase in credit. Also, many agreements, usually deals that involve riskier guarantees such as subprime and Alt-A, use overcollateralization and subordination.
- Credit rating
- Ranking plays a major role in structured finance.
- Another structure
There are many structures that involve participating in mezzanine risk, options and futures in the financing arrangement as well as stripping some interest rate strips. There is no fixed structure that is laid out unlike in Securitization which is only a branch of the whole structured transaction.
Structured financial instruments have several main types
An asset-backed security (ABS) is a type of bond or note based on a collection of assets, or ensured by the cash flow of the underlying pool of assets.
· Mortgage-backed securities (MBS) are asset-backed securities in which their cash flow is supported by the principal and interest payments on a set of mortgage loan.
· Collateralized mortgage liability (CCO) is a mortgage-backed securitization of securities.
Debt Collateral (CNO) consolidates a group of constant income assets such as high yield debt or asset-backed securities into a pool, which is then divided into various tranches.
· Corporate bonds are used to support CMO Collateralized Bond Bonds (CBO).
· Bank loans used to support CMO collateral loan obligations (CLO).
· Credit derivatives are contracts used to transfer the risk of the total return on credit assets that are below the agreed level of the Free Reprint Articles, without transfer of the underlying assets.
· Collateral Liability Fund (CFO) is a securitization of private equity and hedge fund assets. …