Tuesday, March 27, 2007

MBS Fundamentals--Why?

Wikipedia does a nice job of explaining these issues, so I will borrow liberally (with attribution) from them.

Reasons for issuing mortgage-backed securities

(Link above to Wikipedia from which this is lifted)

There are many reasons for mortgage originators to finance their activities by issuing mortgage-backed securities. Mortgage-backed securities

  1. transform relatively illiquid, individual financial assets into liquid and tradeable capital market instruments.
  2. allow mortgage originators to replenish their funds, which can then be used for additional origination activities.
  3. can be used by Wall Street banks to monetize the credit spread between the origination of an underlying mortgage (private market transaction) and the yield demanded by bond investors through bond issuance (typically, a public market transaction).
  4. are frequently a more efficient and lower cost source of financing in comparison with other bank and capital markets financing alternatives.
  5. allow issuers to diversify their financing sources, by offering alternatives to more traditional forms of debt and equity financing.
  6. allow issuers to remove assets from their balance sheet, which can help to improve various financial ratios, utilize capital more efficiently and achieve compliance with risk-based capital standards.
It appears, then, that these securities go along way towards providing substance for derivative instruments such as cash flow swaps and interest rate swaps.

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