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Business & Marketing
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English (U.S.)
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Topic:
Collateralization process and the reasons underlying the decisions
Essay Instructions:
we learned about different fixed income markets (money markets, bond markets, loan markets, mortgages...). Additionally, we also learned the mechanics of collateralized mortgage obligations and collateralized loan obligations. Discuss the collateralization process and the reasons underlying the decisions by financial institutions to collateralize their loan portfolios. Think about how this process creates a wide dispersion of risks associated with this type of assets beyond their origination point.
Furthermore, consider the growth and size of CLO of leveraged loans (loans to highly indebted companies) as a source for triggering another financial crisis when a conflation of events such as a deterioration in the economy, deflation of asset prices and rising risk of default, etc. occur. Evaluate the extent of interconnections within the financial industry that can magnify risks to the financial system.
Additional resources s to help with this discussion.
Valldares, M. (April 15, 2019). Big banks are very exposed to leveraged lending and CLO markets. Forbes.com. Retrieved from https://www(dot)forbes(dot)com/sites/mayrarodriguezvalladares/2019/04/15/big-banks-are-very-exposed-to-leveraged-lending-and-clo-markets/?sh=2f1348e17309
Liu, E., Schmidt-Eisenloher, T. (July 19, 2019). FEDS Notes. Retrieved from https://www(dot)federalreserve(dot)gov/econres/notes/feds-notes/who-owns-us-clo-securities-20190719.htm
Essay Sample Content Preview:
Collateralization Process and The Reasons Underlying the Decisions
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Collateralization Process and The Reasons Underlying the Decisions
The Collateralization Process
The collateralization process refers to a situation where valuable assets are used as collateral in securing a loan. When borrowers default, the lender seizes the valuable asset as a way of recovering their loss. This process is mostly used by lenders to shield themselves from default risks. The collateralization process can either occur through collateralized mortgage obligations (CMOs) or collateralized loan obligations (CLOs). CMOs refer to the kind of mortgage-backed securities that contain pool mortgages which are traded as an investment and are organized in line with risk profiles. CMOs receive cash flows as borrowers repay their mortgages, which serve as collateral (Sanders 7e., n.d). Collateralized mortgage obligations tend to be very sensitive to market economic conditions such as the level of interest rate, refinance rates and property prices. Collateralized loan obligations (CLOs) are single-backed securities that are backed by debt (Liu & Schmidt-Eisenloher, 2019). In most cases, these types of securities are backed by collateral loans taken by private firms or entities with low credit ratings.
The collateralization process unfolds through loan aggregation, the establishment of a Special Purpose Vehicle (SPV), tranching, issuance of securities, and credit enhancement. In loan aggregation, financial institutions such as banks identify loans that have a certain maturity or credit quality. These loans can either be commercial loans, corporate debt, or residential mortgages. After the loans are aggregated, they are channeled to a special legal entity called a Special Purpose Vehicle whose mandate is to identify and manage potent...
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