Question

uestion 10(9 pts); Please answer the following questions about securitization: What are MBS (mortgage-backed securities), CDO (collateralized debt obligations), and synthetic CDO? What are the differences between MBS and CDO? What is SPV (special purpose vehicle)? How did SPV contribute to the financial crisis of 2007- 2009?

Answer 1

1. Mortgage backed security :- it is a type of bond or a financial instrument which was backed by an asset by the issuing authority.

In simple terms we can say that this is a type of financial instrument which is secured by charging an asset. Security issuing authority defaulted in repayment a principal amount on payment of interest the investor in the securities can take over the asset which is charged in favour of this securities. Measure the assets which are given as security for this type of dates are mortgage assets.

2. Collateralized debt obligation :- these are type of structured financial instruments which are issued by a bankers to the institutional investors. This financial instruments are secured with assets laterally given as security for the loans issued by the banks. The nature of this instruments is derivative in nature because of all the benefits will derived from the underlying asset only.

3. Differences between mortgage backed security and collateralized debt obligations :-

A. Mortgage backed securities having an asset as security which is not engaged to the bankers or any other authorities. But collateralized debt obligations are are having an asset which is collateral attached to the obligation of payment of debt.

B. In mortgage backed securities all the benefits received by the institutional investor come from the person who are liable to pay what the benefits in collateralized debt securities who derived from the underlying asset.

4. Special purpose vehicle :- it can be called a special purpose entity which is created by a parent company for the special and particular purpose. Many of the big corporates create special purpose vehicles fore securitization of the debts or undertaking any risky projects.

SPV contributed to the financial crisis of 2007 to 2009

1. The main purpose of special purpose vehicle is to park the excess financial resources available for a corporate.

2. The financial resources which are parked in special purpose vehicle may be used for investment in new projects for securitization of the debts.

3. But there is no compulsory obligation for all the corporates that they have to you surely invest those funds into the market. If they invest in market there will be no financial crisis and no blockage of financial resources.

But if the parent company keep silence on all those financial resources which were held by special purpose vehicle there will be blockage of finance in the economy. And if any corporates created the special purpose vehicle for hiding of excess cash reserves for to escape from the tax compliances this amount will be come black money.

In the both above cases the financial resources are blocked and all the funds are in idle stage. This situation leads to city of the financial resources in the economy and put a pressure on government to release excess finance or excess currency into the market.

This situation automatically leads to financial crisis in the economy. The same situation was happened between 2007 and 2009.

After that any economic reforms are came into existence in all the transactions should be done through banks were made compulsory to avoid same situations in future.

these are all the information and explanations required to solve the above given questions.

If there is any doubts to be clarified regarding the above provided answer, please mention them in comment box.

I hope, all the above mentioned information and explanations are useful and helpful to you.

Thank you.