Definition
Structured finance encompasses securitization techniques that transform illiquid assets (mortgages, loans, receivables) into tradable securities. Through tranching, different risk-return profiles are created from a single asset pool: senior tranches get first claim on cash flows (lowest risk, lowest yield), while equity tranches absorb first losses (highest risk, highest potential return).
lightbulb Example
A bank originates $1B in auto loans and securitizes them: $800M senior notes (AAA, 4%), $150M mezzanine (BBB, 6.5%), $50M equity tranche (unrated, 12%+ target). The bank frees up capital while investors get customized risk exposure.
verified_user Key Points
- Transforms illiquid assets into tradable securities
- Tranching creates multiple risk/return profiles
- Includes MBS, ABS, CDO, CLO structures
- Bankruptcy remoteness protects investors from originator risk