A financial product that is created by pooling together a number of financial assets in order to come up with a new security. The new security constitutes a common part of, and share in, the pool that is sold to investors against its face value.The value, and cash flows, of the security depend on the value, and cash flows, of the underlying components of the pool.
The process of creating such products is known as a securitization. It is involves monetizing financial assets (existing or arising in the future) so that the risks of underlying assets (such as credit risk, prepayment risk, interest rate risk, and liquidity risk) would mainly depend on principal repayment and interest payment on the securities, rather than on the performance of a business or venture.
Securitization helps reduce funding costs. Through securitization (and rather than issue unsecured debt), an entity that is rated BB, for example, but maintains assets (by means of an SPV) that have better credit quality (AAA or AA) can borrow at significantly lower interest rates (reduced funding costs), using the high quality securities as collateral.
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