Financial Market:

Financial market is a mechanism that allows people to buy and sell (trade) financial
securities (such as stocks and bonds), commodities (such as precious metals or agricultural
goods), and other fungible items of value at low transaction costs and at prices that reflect
the efficient-market hypothesis There are two types of financial markets one is general markets
and other is specialized markets. General markets are that where many types of commodities are
traded. And specialized markets are those where only one commodity is traded. Markets work by
placing many interested buyers and sellers in one "place", thus making it easier for them to find
each other. An economy which relies primarily on interactions between buyers and sellers to
allocate resources is known as a market economy.

Financial Institutions:
financial institution is an institution that provides financial services for its clients or members.
Probably the most important financial service provided by financial institutions is acting as
financial intermediaries. Most financial institutions are highly regulated by government.

Types of Financial Institutions:

There are three major types of financial institutions that are as under

 Deposit-taking institutions that accept and manage deposits and make loans, including
loans, including banks, building societies, credit unions, trust companies, and mortgage
loan companies
 Insurance companies and pension funds; and
 Brokers, underwriters and investment funds.
Financial Assets:
A financial asset is an intangible representation of the monetary value of a physical item. It
obtains its monetary value from a contractual agreement of what it represents. While a real asset,
such as land, has physical value, a financial asset is a document that has no fundamental value in
of itself until it is converted to cash. Common types of financial assets include certificates,
bonds, stocks, and bank deposits.

One of the most common types of financial assets is a certificate of deposit (CD). A CD is an

agreement between an investor and a bank in which the investor agrees to keep a set amount of
money deposited in the bank in exchange for a guaranteed interest rate. The bank may offer a
higher amount of interest payment since the money is to remain untouched for a set period of
time. If the investor withdraws the CD before the end of the contract terms, he or she will lose
out on the interest payments and be subject to financial penalties.

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Another type of financial asset is a bond. Bonds are often sold by corporations or governments to
investors in order to help fund short-term projects. They are a type of legal document detailing
the amount of money an investor loaned a borrower and the length of time it needs to be paid. A
bond represents how much interest is guaranteed to be returned to the investor along with the
original loan amount.

Stocks are one of the only financial assets that do not have an agreed upon ending date. Investing
in stock means the investor has part ownership of a company and shares in the company’s profits
and losses. He or she can keep the stock for any length of time or decide to sell it to another
investor.

Money that is deposited into a bank account also counts as a financial asset, rather than a real
asset. When cash is put into a bank account, the proof of the funds is a bank statement that
summarizes the value of the account. Deposited cash is not considered aphysical asset because
the bank uses the money to fund its business and agrees to return it when the account holder
decides to withdraw it.

Valuation of financial assets is the process of determining the amount of cash the assets can be

converted to. This process is often used to find out a person’s personal wealth for legal reasons,
such as his or her ability to pay off a debt. The value of a financial asset can drastically change
depending on the point in time it is valued. For example, the value of stock can change daily
depending on the company’s profits.

Financial intermediary:
A financial intermediary is a financial institution that connects surplus and deficit agents. The
classic example of a financial intermediary is a bank that transforms bank deposits into
bank loans. Through the process of financial intermediation, certain assets or liabilities are
transformed into different assets or liabilities.

Functions of Financial intermediary:

Financial intermediaries provide 3 major functions:

1. Maturity transformation:

Converting short-term liabilities to long term assets (banks deal with large number of

lenders and borrowers, and reconcile their conflicting needs)
2. Risk transformation:

Converting risky investments into relatively risk-free ones. (lending to multiple

borrowers to spread the risk)
3. Convenience denomination:

Matching small deposits with large loans and large deposits with small loans.

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Types of Financial Intermediaries:

 Banks
 Building societies
 Credit unions
 Financial advisers or brokers
 Insurance companies
 Collective investment schemes
 Pension funds

Securitization:
A securitization is a financial transaction in which assets are pooled and securities
representing interests in the pool are issued. An example would be a financing company that has
issued a large number of auto loans and wants to raise cash so it can issue more loans. One
solution would be to sell off its existing loans, but there isn't a liquid secondary market for
individual auto loans. Instead, the firm pools a large number of its loans and sells interests in the
pool to investors. For the financing company, this raises capital and gets the loans off its balance
sheet, so it can issue new loans. For investors, it creates a liquid investment in a diversified pool
of auto loans, which may be an attractive alternative to a corporate bond or other fixed income
investment. The ultimate debtors—the car owners—need not be aware of the transaction. They
continue making payments on their loans, but now those payments flow to the new investors as
opposed to the financing company.

All sorts of assets are securitized:

auto loans
student loans
mortgages
credit card receivables
lease payments
accounts receivable etc.

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Securitization is the financial practice of pooling various types of contractual debt such as
residential mortgages, commercial mortgages, auto loans or credit card debt obligations and
selling said debt as bonds, pass-through securities, or Collateralized mortgage
obligation(CMOs), to various investors. The principal and interest on the debt, underlying the
security, is paid back to the various investors regularly. Securities backed by mortgage
receivables are called mortgage-backed securities, while those backed by other types of
receivables are asset-backed securities. The so-called lower risk of securitised
instruments attracts a greater number of investors seeking to benefit in the process of taking
many individual assets and repackaging them as Collateralized debt obligation.
For example, when a company makes an initial public offering, it effectively packages the
company's ownership into a certain number of stock certificates. Securities are backed by
an asset, such as equity, or debt, such as a portion of a mortgage. Securitization allows a
company access to greater funding to expand its operations or investments, or some other reason.
Types of Securitization:

1.Master trust
A master trust is a type of SPV particularly suited to handle revolving credit card balances, and
has the flexibility to handle different securities at different times. In a typical master trust
transaction, an originator of credit card receivables transfers a pool of those receivables to the
trust and then the trust issues securities backed by these receivables. Often there will be many
trenched securities issued by the trust all based on one set of receivables. After this transaction,
typically the originator would continue to service the receivables, in this case the credit cards.

There are various risks involved with master trusts specifically. One risk is that timing of cash
flows promised to investors might be different from timing of payments on the receivables. For
example, credit card-backed securities can have maturities of up to 10 years, but credit card-
backed receivables usually pay off much more quickly. To solve this issue these securities
typically have a revolving period, an accumulation period, and an amortization period. All three
of these periods are based on historical experience of the receivables. During the revolving
period, principal payments received on the credit card balances are used to purchase additional
receivables. During the accumulation period, these payments are accumulated in a separate
account. During the amortization period, new payments are passed through to the investors.

A second risk is that the total investor interests and the seller's interest are limited to receivables
generated by the credit cards, but the seller (originator) owns the accounts. This can cause issues
with how the seller controls the terms and conditions of the accounts. Typically to solve this,
there is language written into the securitization to protect the investors and potential vegetables.

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A third risk is that payments on the receivables can shrink the pool balance and under-
collateralize total investor interest. To prevent this, often there is a required minimum seller's
interest, and if there was a decrease then an early amortization event would occur.
2.Issuance trust

In 2000, Citibank introduced a new structure for credit card-backed securities, called an issuance

trust, which does not have limitations, that master trusts sometimes do, that requires each issued
series of securities to have both a senior and subordinate tranche. There are other benefits to an
issuance trust: they provide more flexibility in issuing senior/subordinate securities, can increase
demand because pension funds are eligible to invest in investment-grade securities issued by
them, and they can significantly reduce the cost of issuing securities. Because of these issues,
issuance trusts are now the dominant structure used by major issuers of credit card-backed
securities.
3. Grantor trust

Grantor trusts are typically used in automobile-backed securities and REMICs (Real Estate
Mortgage Investment Conduits). Grantor trusts are very similar to pass-through trusts used in the
earlier days of securitization. An originator pools together loans and sells them to a grantor trust,
which issues classes of securities backed by these loans. Principal and interest received on the
loans, after expenses are taken into account, are passed through to the holders of the securities on
a pro-rata basis.
4.Owner trust

In an owner trust, there is more flexibility in allocating principal and interest received to different
classes of issued securities. In an owner trust, both interest and principal due to subordinate
securities can be used to pay senior securities. Due to this, owner trusts can tailor maturity, risk
and return profiles of issued securities to investor needs. Usually, any income remaining after
expenses is kept in a reserve account up to a specified level and then after that, all income is
returned to the seller. 

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Asset Securitization:

Securitization is an open market selling of financial instrument backed by asset cash

flow or asset value.

Asset Securitization is a security whose value and income payments are derived from and
collateralized (or "backed") by a specified pool of underlying assets. The pool of assets is typically a
group of small and illiquid assets that are unable to be sold individually. Pooling the assets into financial
instruments allows them to be sold to general investors, a process called securitization, and allows the
risk of investing in the underlying assets to be diversified because each security will represent a fraction
of the total value of the diverse pool of underlying assets. The pools of underlying assets can include
common payments from credit cards, auto loans, and mortgage loans, to esoteric cash flows from aircraft
leases, royalty payments and movie revenues.

Securitization is the transformation of illiquid assets into a security -- that is, an instrument that
is issued and can be traded in a capital market. Assets that have been transformed in this manner
include residential mortgages, auto loans, credit card receivables, leases and utility payments.
The term asset-backed security (ABS) is generally applied to issues backed by non-mortgage
assets.

Asset securitization techniques are being embraced by a number of Asian countries seeking to
promote home ownership, to finance infrastructure growth, and to develop their domestic capital
markets. Asset securitization differs from collateralized debt or traditional asset-based lending in
that the loans or other financial claims are assigned or sold to a third party, typically a special-
purpose company or trust. This special-purpose vehicle (SPV) in turn issues one or more debt
instruments -- the asset-backed securities --whose interest and principal payments are dependent
on the cash flows coming from the underlying assets.

Types of Assets Securitization:

Leases Loans Receivables Others

Vehicle leases Car loans Credit card receivables Subsidies

Equipment Commercial Trade receivables Royalty income
leases property loans Phone bill receivable Ticket income
Aircraft leases Bank loans Utilities receivables
Train leases Project loans Toll free receivables
Ship leases Tuition/ student Insurance receivables
Share leases loans Mail order receivables
Bad loans

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Financial Innovation:
The creation of a new investment vehicle. For example, one may structure a derivative in a way
that has never been done before. Financial innovation can increase efficiency and profits for
certain parties. However, it often takes time for regulation to catch up to financial innovation,
which can make it risky.

Types of Financial Innovation:

 Financial system/institutional innovations:

Such innovations can affect the financial sector as a whole, relate to changes in business
structures, to the establishment of new types of financial intermediaries, or to changes in the
legal and supervisory framework. Important examples include the use of the group mechanism to
retail financial services, formalizing informal finance systems, reducing the access barriers for
women, or setting up a completely new service structure.

 Process innovations:

Such innovations cover the introduction of new business processes leading to increased
efficiency, market expansion, etc. Examples include office automation and use of computers
with accounting and client data management software.

 Product innovations:

Such innovations include the introduction of new credit, deposit, insurance, leasing, hire
purchase, and other financial products. Product innovations are introduced to respond better to
changes in market demand.

Asset Securitization as a Financial Innovation:

A key financial innovation in the 1980s that dramatically influences the role of financial
intermediaries is the phenomenon of asset securitization. The process involves the collection of
or pooling of loans and the sales of securities backed by those loans. This system is radically
different from the traditional system for financing the acquisition of assets, which called for one
financial intermediary, such as a depository institution or insurance company, to: (1) originate a
loan (2) retain the loan in its portfolio of assets, thereby accepting the credit risk associated with
the loan (3) service the loan-collect payments and provide tax or other information to the
borrower; and (4) obtain funds from the public with which to finance its assets.

Asset securitization means that more than one institution may be involved in lending capital.
Consider the loans for the purchase of automobiles. A lending scenario can look like this: (1) A
commercial bank can originate automobiles loans;(2) the commercial bank can issue securities
backed by these loans; (3) the commercial bank can obtain credit risk insurance for the pool of

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loans from a private insurance company; (4) the commercial bank can sell the right to service the
loans to another company that specializes in the servicing of loans; and (5) the commercial bank
can use the services of a securities firm to distribute the securities to individuals and institutional
investors.

Potential Benefits/Motivations:
To owner/originator

 Alternative financing instruments

 Improve liquidity in the balance sheet

 Reinvestment and freeing up the low-yield assets

 Transfer the interest rate risks to SPV

To bondholders/investors

 New Investment opportunities for diversification

 Direct participation in real estate market by small investors

 Partial sharing of future capital gain through preference shares

 Building as collateral

To Real Estate Market

 An active secondary capital market for institutional investment

 Alternative Financing Options

Conclusion
 Securitization would be an important financing instrument when interest rate is more
volatile

 Transparent and fair valuation of securitization deal is important

 Contributing to the efficient pricing and structuring of future securitization deals

 Advancing the valuation and pricing techniques that are applicable for the asset
securitization