Security is a financial instrument that represents an ownership interest in an asset.
- In the context of securitisation, the asset is typically a pool of loans.
Securities are issued by a special purpose vehicle (SPV) that is created for the securitisation.
The SPV then uses the proceeds from the sale of the securities to purchase the pool of loans.
The securities are then divided into different tranches, with each tranche having a different risk profile.
The tranches with the highest risk are typically issued at a lower price, while the tranches with the lowest risk are typically issued at a higher price.
Investors who purchase the securities are essentially buying a share of the pool of loans.
If the borrowers on the loans make their payments, the investors will receive their interest payments and principal repayments.
However, if the borrowers default on their loans, the investors may not receive their full investment back.
Here are some applications of security in securitisation:
- To raise capital: Securities can be used by securitisation issuers to raise capital. This is because securities can be sold to investors, who will provide the capital that is needed to purchase the pool of loans.
- To reduce risk: Securities can be used by securitisation issuers to reduce risk. This is because the securities are divided into different tranches, with each tranche having a different risk profile. This allows investors to choose the tranche that is most appropriate for their risk tolerance.
- To attract investors: Securities can be used by securitisation issuers to attract investors. This is because securities can offer investors a higher yield than other types of investments, such as bonds.