Structured finance is a complex section of finance that has a scale that is too large for ordinary loan or bond. It manages risks and leverages, which involves corporate and legal restructuring, use of financial instruments, and off-balance sheet accounting. Some of the commonly known examples are mortgage-backed securities, syndicated loans and collateralized debt obligation.
There are normal types of financial instruments that are available in the market that help in financing a transaction. These financial instruments include overdrafts and mortgages which look at the creditworthiness of the borrower. However, there are some of the borrowers in the market who have unique requirements for financial instruments. This calls for structured finance as it helps to dampen the risks of securitizations of specific assets.
Since the mid-1980s, this type of finance has been of great significance to the large companies which need complicated financing that does not match the usual financial instruments. The major aim of structured finance is to create structured risk mitigation products for companies when looking at classes of assets and number of industries.
There are a number of structured finance examples in the finance market today. These options include
Securitization is a major element in structure finance. Here, the non-tradable assets are pooled together to form their own financial instruments that can be issued to help investors who are in need of special finance. The financial instrument attracts interest to the investors. The core aim of securitization is to create more liquidity in the market.
For example, MBS is structured finance that creates a pool of mortgages which allows an issuer to assess the chances of the default payment and risk levels before creating smaller pools known as tranches. The investors then decide on which tranches they will participate in considering their own appetite for risk and due diligence. These different tiers of levels of risks increase liquidity in the market.
A structured note is a security of a debt that is issued by the financier. The returns on a structured note are based on the performance of the pools of asset i.e.,
Although structured finance requirements are case-by-case based, there are common requirements that a financier will request during application. These requirements are
Structured finance is significant due to the following reasons:
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