Valuation and Risk Management in Structured Finance
Expert-defined terms from the Professional Certificate in Structured Finance course at UK School of Management. Free to read, free to share, paired with a globally recognised certification pathway.
Valuation and Risk Management in Structured Finance #
Valuation and Risk Management in Structured Finance
Structured finance refers to complex financial transactions that are typically u… #
Valuation and risk management play a crucial role in structured finance by determining the value of these assets and assessing the associated risks. In this glossary, we will explore key terms related to valuation and risk management in structured finance.
Asset #
Backed Security (ABS)
An asset #
backed security is a type of security that is backed by a pool of assets such as loans, leases, or receivables. These assets serve as collateral for the securities, providing investors with cash flows based on the performance of the underlying assets.
Collateralized Debt Obligation (CDO) #
Collateralized Debt Obligation (CDO)
A collateralized debt obligation is a type of structured finance product that po… #
These debts are divided into tranches with varying levels of risk and return.
Counterparty Risk #
Counterparty Risk
Counterparty risk refers to the risk that a party to a financial transaction wil… #
In structured finance, counterparty risk can arise from derivative contracts, repurchase agreements, or other financial instruments.
Credit Enhancement #
Credit Enhancement
Credit enhancement refers to measures taken to improve the credit quality of a s… #
These measures can include overcollateralization, guarantees, insurance, or reserves to protect investors from potential losses.
Credit Rating #
Credit Rating
A credit rating is an assessment of the creditworthiness of an issuer of debt se… #
Credit ratings are assigned by credit rating agencies based on the issuer's ability to meet its financial obligations.
Derivative #
Derivative
A derivative is a financial instrument whose value is derived from an underlying… #
Derivatives are often used in structured finance to hedge risks or speculate on market movements.
Interest Rate Risk #
Interest Rate Risk
Interest rate risk refers to the risk that changes in interest rates will affect… #
In structured finance, interest rate risk can impact the cash flows of assets and liabilities.
Model Risk #
Model Risk
Model risk refers to the risk that a financial model used for valuation or risk… #
In structured finance, model risk can arise from assumptions, data inputs, or the complexity of the model.
Prepayment Risk #
Prepayment Risk
Prepayment risk refers to the risk that borrowers will repay their loans earlier… #
In structured finance, prepayment risk can impact the returns of investors.
Rating Agency #
Rating Agency
A rating agency is a company that assesses the creditworthiness of issuers of de… #
Rating agencies play a critical role in structured finance by providing independent evaluations of securities.
Securitization #
Securitization
Securitization is the process of transforming illiquid financial assets, such as… #
These securities are then sold to investors, providing liquidity to the originators of the assets.
Seniority #
Seniority
Seniority refers to the order in which investors will be repaid in the event of… #
In structured finance, securities are often structured into tranches with different levels of seniority based on their priority of payment.
Structural Risk #
Structural Risk
Structural risk refers to the risk that the structure of a financial transaction… #
Structural risk can arise from the complexity of the transaction or the performance of the underlying assets.
Tranche #
Tranche
A tranche is a portion of a security that is structured with different levels of… #
In structured finance, securities are often divided into tranches to appeal to investors with varying risk preferences.
Underlying Asset #
Underlying Asset
An underlying asset is the financial asset or index on which a derivative or a s… #
In structured finance, the performance of the underlying assets determines the value and risk of the structured products.
Valuation #
Valuation
Valuation is the process of determining the fair value of a financial asset or l… #
In structured finance, valuation is crucial for pricing securities, assessing risks, and making investment decisions.
Yield Curve Risk #
Yield Curve Risk
Yield curve risk refers to the risk that changes in the shape or slope of the yi… #
In structured finance, yield curve risk can affect the returns of securities with varying maturities.
Z #
Spread
The Z #
spread is a measure of the credit risk premium added to the yield of a security to compensate investors for the risk of default. In structured finance, the Z-spread is used to compare the relative value of securities with different credit qualities.