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Securitisation and the financial crisis

Securitisation and the financial crisis. Do CDOs benefit or harm the financial system?. Matthew Britt and Michael Capleton. Introduction . Defining structured finance - Why does it exist? - A closer look at Collateralised Debt Obligations (CDOs)

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Securitisation and the financial crisis

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  1. Securitisation and the financial crisis Do CDOs benefit or harm the financial system? Matthew Britt and Michael Capleton

  2. Introduction • Defining structured finance- Why does it exist?- A closer look at Collateralised Debt Obligations (CDOs) • Explaining the advantages of CDOs and their benefits to the financial system • Explaining the disadvantages of CDOs and how they harm the financial system

  3. Structured finance • Takes a pool of assets, dividing up the income stream into ‘tranches’. • Creates relatively safe securities from securitised assets

  4. Collateralised debt obligations • “Special purpose vehicles that issue long-dated liabilities in the form of rated tranches in the capital markets” (Gorton 2009) • Most easily categorised by- Cash CDOs- Synthetic CDOs- Hybrid CDOs • Senior tranche given AAA rating

  5. conclusion • Up until the crisis, CDOs and structured finance in general was seen as beneficial.. They add liquidity to the financial system, as well as allowing investors of all risk attitudes to purchase investment vehicles; some more risky with a higher return, some seen as ‘safe’. • However, when these AAA rated CDOs turned out to be completely unsafe, views on CDOs changed. • CDOs are seen as a large reason for the recent financial crisis. They played a big part in the subprime mortgage market, therefore they are seen as harmful to the financial system.

  6. references • Bolton et al: ‘The Credit Ratings Game’ – The Journal of Finance (2012) • Brunnermeier, Markus K: ‘Deciphering the Liquidity and Credit Crunch’ – Journal of Economic Perspectives, Vol. XXIII, No. 1 (2009) • Gorton, Gary: ‘The Subprime Panic’ - European Financial Management, Vol. XV, No. 1 (2009) • University of Pennsylvania: ‘CDOs Are Back: Will They Lead to Another Financial Crisis?’ (2013)

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