Structured Finance and the Financial Turmoil of 2007 2008

For example the credit derivatives statistics

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For example, the credit derivatives statistics published by the BBA include only synthetic CDOs and not “cash flow” CDOs . The most important instruments belonging to “pure” credit derivatives are credit default swaps (CDS), with other instruments here are, in addition to synthetic CDOs, credit-linked notes, total return swaps and credit spread options. These latter three instruments will not be discussed. In relation to the financial turmoil of 2007-2008, different groups of structured finance instruments played different roles. First, a number of these instruments were at the heart of the financial market tensions, as due to uncertainties about their valuations and exposures to the US (subprime) mortgage markets, investors started to shun them en masse. Subsequently, these tensions spilled over to other segments of the credit markets, other financial markets such as the equity and foreign exchange markets and the financial services industry, in particular (investment) banks which significant exposures to these instruments. The structured finance instruments involved in this process were in particular (subprime) residential mortgage-backed securities (RMBS), asset-backed commercial paper (ABCP) and collateralized debt obligations (CDOs), including both “cash flow” and “synthetic” CDOs.
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BANCO DE ESPAÑA 13 DOCUMENTO OCASIONAL N.º 0808 Second, certain structured finance instruments were involved only indirectly in the turmoil, but provided very useful information on the development of the financial market tensions. This applies particularly to credit default swaps (CDS). These financial contracts have been instrumental in monitoring pressures in specific market segments through CDS index contracts, which are representative for a group of companies, as well as uncertainties about the soundness and viability of individual commercial and investment banks and insurance companies through single name CDS contracts. Both groups of structured finance instruments related to the financial turmoil will be discussed in the subsequent sections.
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Figure 1: Structured finance instruments and securitization SOURCE: Own interpretation based on Jobst (2003) and (2006) and BIS (2005a). Structured finance instruments Securitisations: Creation of Asset-Backed Securities (ABS) “Pure" credit derivatives Short-term ABS: Asset-Backed Commercial Paper ( ABCP ) (Longer) term ABS (in a broad sense) Credit default swaps ( CDS ) Other credit risk transfer instruments Mortgage- Backed Securities ( MBS ) ABS (in a narrow sense) Residential Mortgage- Backed Securities ( RMBS ) Commercial Mortgage- Backed Securities ( CMBS ) Collateralised Bond Obligations ( CBO ) Collateralised Loan Obligations ( CLO ) Credit card receivables ABS Car loans ABS Student loans ABS Other ABS Subprime Prime Resecuritization : Structured Collateralized Debt Obligations: CDOs based on ABS in a narrow sense ( ABS CDO ) Collateralized Mortgage Obligations ( CMO ), which is a CDO based on MBS CDOs based on CDOs ( CDO 2 ) Cash flow Collateralized Debt Obligations ( CDO ) Synthetic Collateralized Debt Obligations ( CDO ) BANCO DE ESPAÑA 14 DOCUMENTO OCASIONAL N.º 0808
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