Residual value is the estimated value of an asset at the end of its lease term or useful life. In the context of securitisation, residual value is an important factor in determining the amount of cash flow that will be generated by the securitisation.
The residual value of an asset can be affected by a number of factors, including:
- The type of asset: The residual value of a car is likely to be different from the residual value of a piece of equipment.
- The condition of the asset: The residual value of an asset will be lower if the asset is in poor condition.
- The market for the asset: The residual value of an asset will be lower if there is a limited market for the asset.
In a securitisation, the residual value of the underlying assets is typically used to determine the amount of credit enhancement that is required.
Credit enhancement is a financial mechanism that is used to protect investors from losses in the event of default on the underlying assets.
The amount of credit enhancement that is required will depend on the estimated residual value of the underlying assets and the level of risk that the investors are willing to accept.
Here are some applications of residual value in securitisation:
- Mortgage-backed securities: In a mortgage-backed security, the residual value of the underlying mortgages is typically used to determine the amount of credit enhancement that is required.
- Collateralized debt obligations: In a collateralized debt obligation, the residual value of the underlying debt securities is typically used to determine the amount of credit enhancement that is required.
Residual value is an important consideration in securitisation. It is important to understand the factors that affect residual value in order to assess the risk of a securitisation.