Securitisation - the Foundation of the U.S. & Global Financial System

The process of restructuring and re-packaging a pool of financial assets yielding future cash-flows is called securitisation. Such Financial instruments are called Securities, specifically Asset-Backed Securities Any financial asset yielding future cash flows can be securitised by the above process. Assets are usually Financial in nature such as Bank Loans - Home, Personal, Vehicle or Credit Card Loans and other short-term loans which show up on the books of the lending banks.

In the above process, the Originator (of the Asset-backed Security) has the advantage of transferring the default risk / credit risk to a third-party who would be an investor in the Securities sold by the Originator. The advantage to the investor is the access to future cash-flows at a present-value discounted price.

The process of Securitisation is combined with Credit Derivatives in order to retain investor's confidence in the credit-worthiness of the Securities.

Credit Derivative:

A Derivative is a financial instrument which derives it's value from that of an underlying asset.

A Credit Derivative derives its value from the credit risk of an underlying bond, loan or any other financial asset. When the underlying financial asset is being sold by an Originator to an Investor, a Credit Derivative provides insurance against credit / default risk. This is provided by an entity other than the counterparties to the underlying financial transaction. Credit Derivatives are Bi-party contracts between a buyer and a seller according to which, the seller sells protection against the credit risk of a security transaction between an Originator and an investor. Credit Derivatives can be Credit Default Swaps (CDS) or Collaterallised Debt Obligations (CDO).

The main participants of this market are Hedge Funds, Investment Banks, Pension Funds.