Securitization

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Securitization
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Securitization of assets is a process through which an issuer creates a financial instrument by transforming an illiquid asset such as receivables into securities, in order to sell it to investors. Those instruments are secured by future cash flows connected with asset. The purpose of this transaction can be shortening of collection period at one hand and on the other transferring risk of insolvency. Securitization is a common form of financing an operational business especially among banks.

Structure of the process

The assets that are typically securitized include mortgages, auto loans, credit card receivables, and other types of consumer and commercial debt.

The process of securitization involves several steps:

  • The issuer (e.g., a bank or financial institution) gathers a pool of assets, such as mortgages or loans, and transfers them to a special purpose vehicle (SPV).
  • The SPV issues securities, such as bonds or notes, which are backed by the pool of assets. The securities are then sold to investors.
  • The proceeds from the sale of the securities are used to pay off the original loans or mortgages, and the issuer is no longer responsible for the underlying assets.
  • The investors in the securities receive cash flows from the underlying assets, such as interest payments and principal repayments.

Securitization allows the issuer to free up capital and reduce risk by transferring the assets to the SPV. It also provides investors with access to a diversified pool of assets that they might not otherwise have the opportunity to invest in.

References

Author: Krzysztof Nadzieja