Ch 4 - Specialist Asset Classes (2) Flashcards
Securitisation
Issue of securities, usually bonds, where the bonds are serviced and repaid exclusively out of a defined element of future cashflow owned by the issuer
Therefore converts a portfolio of often unmarketable assets into a structured financial instrument which is then negotiable
The key requirement for an asset to be used as the basis of a securitisation is that it generates a reasonably predictable income stream
The bondholders have no claim on any other cashflows or assets of the issuer (due to SPV)
Classes of Securitised Assets:
MBS CCABS CBO CLO CDO Insurance securitisations
Risks with securitisation
Prepayment risk
Credit risk
SPV
Original owner of the assets sells those assets that are to be the basis of the securitisation to a corporate entity called a SPV
SPV raises funds to purchase the assets by issuing debt securities (ABS) to investors
The cashflows received on the secured assets (the receivables) are transferred into the SPV and used to meet the principle and interest payments on the debt
SPV is a separate legal entity – usually a company in its own right
SPV structured to be “bankruptcy remote” in the vent of the failure of the borrower (or in event of default of SPV)
Structure of CLOs, CBOs and CDOs + 2 advantages
Pool of securitised assets are used to back several different tranches of ABS
Cashflows from the portfolio are divided up into tranches and assigned to the different new securities created
Thus the cashflows from the underlying portfolio might be used to create:
- Bond with a fixed coupon. Most senior security and its coupons are paid first. It is termed senior debt and might carry a AAA rating
- Bond whose coupons are paid as long as there is enough left after the payments to the senior debt is made. BB rating. Known as the mezzanine piece or tranche
- Claim on the residual cashflows.
Thus new securities have different credit risk features by construction and appeal to a wider range of investors
This could thus reduce the overall cost of borrowing
Private Equity
Is investment in unquoted companies that are not listed on a stock exchange (thus, there is no immediate exit route via the secondary market )
Forms of Private Equity
Venture capital Leveraged buy-outs -management buy-outs -management buy-ins Development capital Restructuring capital
Advantages of taking a Public Company into Private Ownership (5)
Fewer regulatory restrictions
Closer relationship with small number of sophisticated investors who may provide management input
Incurs lower costs (less reporting for example)
Lack of a quoted market share price - management takes a longer-term view
Possibly may be able to reduce cost of capital under private ownership
Advantages of Private Equity (as an asset class)
Out-perform
Loosely correlated asset - diversification
Disadvantages of PE to II
Higher default risk
Less marketable
Less transparent
Lack of track record and information
Expertise required
Regulatory constraints
Less liquid - restrictions on who can sell to and when
Difficult to value
High gearing with LBO
Ways to invest in PE
Directly by purchasing shares in private companies
Pay a private equity firm to invest for you
Invest in a private equity collective vehicle – investment trust
Invest in a fund-of-funds
Cashflows of a PE fund
Fund raising period 3-6 months prior to launch of fund
Series of further fund raising periods with closing dates over next 3-4 years
Monies committed are called upon in fund raising period
Invested in tranches
Fund may start making cash distributions after about 3 years
Fund will have made all investment purchases by end of investment period
Fund wound up after 8-12 years
Hedge fund definition
Investment fund that aims to meet high or absolute returns by investing across a number of asset classes or financial instruments.
It is a type of collective investment vehicle.
Aren’t restricted to a long-only, non-leveraged investment strategy and thus typically have less restrictions on:
- Borrowing
- Short-selling
- Derivatives
General features of hedge funds (in addition to 3 obvious ones)
FFML RLS
Freedom
Fees for performance
Minimum investment amount = high
Limits on total size of fund
Risk tolerance is higher
Lock-up periods
Strategies are best executed with relatively small amounts
Classes of Hedge Funds
Global tactical asset allocation funds
Event-driven funds
Market-neutral funds
Multi-strategy funds
Global Macro Fund
Concentrate on economic changes around the world and sometimes make extensive use of leverage and derivatives
Therefore will be a combination of short and long positions that reflect the manager’s views on how macroeconomic factors such as levels of international asset markets, interest rates and currencies will move
View is influenced by global market trends and major international events.
