Securitization and Competitive Strategy - Assignment Example

Banking Securitization The financial practice of pooling various types of debts mainly contractual such as residential and commercial mortgages, credit card obligations and auto loans and selling the bonds to various investors is known as Securitization. Other descriptions are the processes of liquidifying assets through financial engineering in order to transform them into a security. Mortgage Backed Security (MBS) is an example of securitization as supported by Abuzz & Berliner (2007). This is an example of an asset backed security which is secured by a collection of mortgages. The procedure operates as follows: first of all, there is a regulated and authorized organization originating numerous mortgages. The mortgages are secured by claims against the various estates the mortgagors purchase. Afterwards, the individual mortgages are huddled together as a mortgage pool. The pool is held as the collateral for an MBS. The MBS can also be issued by a third-party financial institution for instance a large investment banking company or similar bank where the mortgages originated from. Aggregators can also issue mortgage backed securities. There are MBS whose main purpose and interests are guaranteed by a United States government entity or sponsored enterprise. The securities are known as agency MBS which do not expose an investor to credit risk. For a non-agency MBS, issuers normally employ various vehicles to enhance the credit of the security in order to obtain a targeted investment-grade rating. Investors within MBS are exposed to uncertainties about the future cash flow since the borrower has every right to repay the loan wholly or partial as long as it is before the maturity date. This is called prepayment risk which is a major factor in understanding MBS. When the MBS is being created, an issuer would choose to break the mortgage pool severally to different parts known as tranches. These tranches are structured in various forms depending on the choice of issuer. The tranches differ in relation to the priorities of payments received. These early payments must then be allocated to the tranches according to a schedule or priority. This allows the issuer to tailor a single MBS in case of risks and damages. The funds accumulated for example Pensions and hedges are used to invest in high credit mortgage securities and seek higher returns through investing in low credit ratings. A vital innovation in the financial markets has been the securitization of assets. Apparently, this would include mutual funds as securitized investments. Interestingly, securitized investments normally distinguish themselves by the fact that they change priorities of payments to the holders of the securities. The first type of securitized asset was the residential mortgage in 1969 and the first non-mortgage asset securitization were the lease received in 1985. Since then, credit cards, loans and bonds and several other types of debt instruments have been securitized. Considering the prepayment risk that an investor faces in the basic mortgage-backed instrument as well as the pass through security, there is a very high chance of enquiring huge losses. For instance when interests rate fall, homeowners usually begin prepaying their mortgages while leaving mortgage holders normally receive their principle payments earlier than scheduled. Consequently, the cash flow has to be invested in lower interest rate environments according to Chance (2008). As a result, the returns on mortgage pass-through are quite volatile shocking the many investors who were unaware that such a risk would occur. Nonetheless, the result is similar that a new security is created and backed up by the claims against the mortgagors’ property. However, this security can be sold to participants who are in the secondary mortgage market. The secondary mortgage market is very large hence providing a significant amount of liquidity to the mortgage groups. Competitive Strategy With the business environment continuously becoming more challenging and taking a global twist, companies see a greater need to develop and implement measures that are aimed at securing their operations in a sustainable way, against competition (Day and Gunther, 2004). Competitive strategy has a lot to do with the manner in which an organization competes in the market with other players offering similar products or services. The current dynamic markets and new technologies have given rise to the issue of sustainability of competitive advantage. There is pressure to improve productivity, quality and speed so as to measure up to competition while meting market demands. Due to this, managers have embraced tools such as TQM (Total Quality Management), benchmarking, Kaizen (continuous improvement) and reengineering according to Teicholz and Ikeda (1995). As a result, there have been dramatic operational results among various companies. However, these gains rarely translate to sustainable profitability. Slowly, these tools are being replaced by strategy. Efforts by managers to improve all fonts unfortunately have led them further away from competitive positions. Operational effectiveness is necessary to superior performance but not sufficient enough. This is due to the fact that its techniques are easy to imitate. Clearly, the essence of strategy is to choose a unique and valuable position that is rooted in systems of activities that are much more difficult to compete with. To become a market leader there must be practice of competitive leadership strategies as supported by Day and Gunther (2004). A market leader is a dominant force in its industry and has substantial shares in the market too. In order to become the industry leader, some of the strategies include the development and adoption of new business models as well as new products and services. Another strategy is being on the cutting edge of new technologies as well as innovative business processes. In addition, products must be differentiated well enough and finally, the organization must have the superior capacity to handle clients’ problems solving them accordingly. Strategy is increasingly dynamic in nature. The strength of a given strategy is not determined by the initial move but rather how smartly it addresses changes in the competitive environments. They include regulations, technologies and other sources. In many industries, the pace of change in the competitive environment has increased. Subsequently, so has the need for explicit recognition of this dynamism while formulating competitive strategies. References Abuzz J. and Berliner W., 2007, Mortgage-backed securities: products, structuring, and analytical technique. John Wiley and Sons. Chance D., 2008, Essays in derivatives: risk-transfer tools and topics made easy. John Wiley and Sons. Day G. and Gunther R., 2004, Wharton on Dynamic Competitive Strategy. On Wiley and Sons. Teicholz E. and Ikeda T., 1995, Facility management technology: lessons from the U.S. and Japan. John Wiley and Sons. Read More