Banking Assignment Example | Topics and Well Written Essays - 1000 words

Banking - Assignment Example The mortgages are secured by claims against the various estates the mortgagors purchase. Afterwards, the individual mortgages are huddled together as a mortgage pool. The pool is held as the collateral for an MBS. The MBS can also be issued by a third-party financial institution for instance a large investment banking company or similar bank where the mortgages originated from. Aggregators can also issue mortgage backed securities. There are MBS whose main purpose and interests are guaranteed by a United States government entity or sponsored enterprise. The securities are known as agency MBS which do not expose an investor to credit risk. For a non-agency MBS, issuers normally employ various vehicles to enhance the credit of the security in order to obtain a targeted investment-grade rating. Investors within MBS are exposed to uncertainties about the future cash flow since the borrower has every right to repay the loan wholly or partial as long as it is before the maturity date. This is called prepayment risk which is a major factor in understanding MBS. When the MBS is being created, an issuer would choose to break the mortgage pool severally to different parts known as tranches. These tranches are structured in various forms depending on the choice of issuer. The tranches differ in relation to the priorities of payments received. These early payments must then be allocated to the tranches according to a schedule or priority. This allows the issuer to tailor a single MBS in case of risks and damages. The funds accumulated for example Pensions and hedges are used to invest in high credit mortgage securities and seek higher returns through investing in low credit ratings. A vital innovation in the financial markets has been the securitization of assets. Apparently, this would include mutual funds as securitized investments. Interestingly, securitized investments normally distinguish themselves by the fact that they change priorities of payments to the holders of the securities. The first type of securitized asset was the residential mortgage in 1969 and the first non-mortgage asset securitization were the lease received in 1985. Since then, credit cards, loans and bonds and several other types of debt instruments have been securitized. Considering the prepayment risk that an investor faces in the basic mortgage-backed instrument as well as the pass through security, there is a very high chance of enquiring huge losses. For instance when interests rate fall, homeowners usually begin prepaying their mortgages while leaving mortgage holders normally receive their principle payments earlier than scheduled. Consequently, the cash flow has to be invested in lower interest rate environments according to Chance (2008). As a result, the returns on mortgage pass-through are quite volatile shocking the many investors who were unaware that such a risk would occur. Nonetheless, the result is similar that a new security is created and backed up by the c laims against the mortgagors’ property. However, this security can be sold to participants who are in the secondary mortgage market. The secondary mortgage market is very large hence providing a significant amount of liquidity to the mortgage groups. Competitive Strategy With the business environment continuously becoming more challenging and taking a global twist,