- Structured finance
Structured finance is a broad term used to describe a sector of
financethat was created to help transfer riskusing complex legal and corporate entities.
Securitization is the method which participants of structured finance utilize to create the pools of assets that are used in the creation of the end product financial instruments.
Tranching is an important concept in structured finance because it is the system used to create different investment classes for the securities that are created in the structured finance world."Tranching allows the cash flow from the underlying asset to be diverted to the various investor groups." The Committee on the Global Financial System explained tranching succinctly:"A key goal of the tranching process is to create at least one class of securities whose rating is higher than the average rating of the underlying collateral pool or to create rated securities from a pool of unrated assets. This is accomplished through the use of credit support (enhancement), such asprioritisation of payments to the different tranches."
Credit enhancement is key in creating a security that has a higher rating than the issuing company.
Ratings play an important role in structured finance.
There are numerous structures which may involve mezzanine risk participation, Options and Futures within structuring of financing as well as multiple stripping of interest rate strips. There is no laid-out fixed structure unlike in Securitization which is only a subset of the overall structured transactions. Esoteric transactions often have multiple lenders and borrowers distributed by distribution agents where the Structuring entity may not be involved in the transaction at all.
There are several main types of structured finance instruments.
*Asset-backed securities (ABS) are bonds or notes based on pools of assets, or collateralized by the cash flows from a specified pool of underlying assets.
*Mortgage-backed securities (MBS) are asset-backed securities whose cash flows are backed by the principal and interest payments of a set of mortgage loans.
Collateralized mortgage obligations (CMOs) are securitizations of mortgage-backed securities.
Collateralized debt obligations (CDOs) consolidate a group of fixed income assets such as high-yield debtor asset-backed securities into a pool, which is then divided into various tranches.
Collateralized bond obligations (CBOs) are CDOs backed primarily by corporate bonds.
Collateralized loan obligations (CLOs) are CDOs backed primarily by leveraged bank loans.
Credit derivatives are contracts to transfer the risk of the total return on a credit asset falling below an agreed level, without transfer of the underlying asset.
Collateralized Fund Obligations (CFOs) are securitizations of private equityand hedge fundassets.
* [http://www.tpw.com/resources/documents/Thacher_Proffitt_SF_Common_Terms_Nov_07.qxd.pdf Thacher Proffitt & Wood LLP (2007). "Common Terms in Structured Finance"]
* [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=832184 Jobst, Andreas A. (2007). "A Primer on Structured Finance" "Journal of Derivatives and Hedge Funds"]
* [http://www.businessweek.com/magazine/content/06_47/b4010107.htm Tergesen, Anne (2006). "Structured Notes: Quirkiest Vehicle on the Street", "Business Week"]
* [http://www.thestreet.com/pf/markets/matthewgoldstein/10174866.html Goldstein, Matthew (2004). "Post-Enron, Structured Finance Addiction Hasn't Ebbed" "TheStreet.com"]
Thomson Financial League Tables.
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