Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques

UNDERLYING LOGIC IN STRUCTURING CASH FLOWS

The goal of structuring is to maximize the proceeds received for the sale of any loans through the mechanism of securitization. Dealers, either acting as agents for an originator or as principals, seek to create structures that can be sold at the highest price, given market conditions, demand for various structured products, and the cost of creating such securities.

There are two primary ways that structuring cash flows maximizes deal proceeds and thus improves execution. Splitting and tranching cash flows allows bonds to be created to better match the specific risk-andreturn profiles of different investor clienteles. As noted earlier in this book, the different segments of the fixed income markets have fairly standard duration and convexity preferences. In addition, investors within a market segment may vary in terms of their investment needs. For example, while banks typically invest in short-duration assets, each institution will have its own investment guidelines and performance measures. Cash flow structuring allows bonds to be created that more closely adhere to the investment objectives of a variety of investors and institutions.

The type of structuring described above typically takes place in agency deals and the senior (i.e., triple-A) bonds created off a private label structure. Many of the techniques discussed in later chapters are used to modify the return-and-risk profiles of the senior bonds by altering how principal ...