Securitisation is a financial process that involves pooling together similar income-generating assets that might be challenging to trade individually. These assets are then sold to a specially created third party. This third party utilizes these assets as collateral to issue securities, which are then marketed in financial markets. This technique essentially transforms illiquid assets into securities that can be traded, thereby unlocking their value.
The process of securitisation begins with the identification of homogeneous income-generating assets. These could include various types of loans such as mortgages, auto loans, or credit card debt. These assets are grouped together based on their similarities, such as maturity, interest rate, and risk profile. Once grouped, they are transferred to a special purpose vehicle (SPV), a separate legal entity created solely for this purpose. The SPV holds these assets and issues securities against them, backed by the cash flows generated from the underlying assets.
Investors purchase these securities, attracted by the collateral and the promised returns. The cash flows from the underlying assets, such as loan repayments, are used to pay interest and principal to the investors holding the securities. By spreading the risk among multiple investors and providing a steady income stream, securitisation benefits both the original lender, who can free up capital to issue more loans, and the investors, who gain access to diversified investment opportunities.
(Response: Securitisation involves pooling together similar income-generating assets, which are then sold to a special purpose vehicle (SPV) to issue securities. These securities are backed by the cash flows from the underlying assets and are sold to investors in financial markets, providing a way to unlock the value of illiquid assets.)