Asset Backed Securities (ABS) – products of the securitisation process sold in capital markets. Three types of asset securities include:
Mortgage Backed Securities (MBS) – backed by mortgages
Collateralised Debt Obligations (CDO) – backed by bonds
Collateralised Loan Obligations (CLO) – backed by loans
Securitisation – refers to the process of pooling and repackaging homogenous illiquid assets into marketable securities which are eventually sold to investors.
Trust – private agreement between parties. Special Purpose Vehicles (SPVs) are trusts created for the purposes of securitisation transactions. In pass-throughs, the interests earned on receivables are passed onto investors with SPVs used as distribution instruments. In contrast, pay-throughs involve using the SPVs to issue new securities to security holders while paying out interests at fixed points.
Waterfall Principle – using the waterfall as an analogy, there is a cascading effect in terms of securitisation transactions; where depending on the rank of the tranche you are in as an investor, the payout for capital and interests will follow. The higher your rank, the greater the precedence of payout and claims. For e.g., in a situation when it comes to losses, the allocation of losses come from the “lower ranked” giving “protection” to the more ” senior” tranches. The reverse happens when it comes to gains.
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