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Definition of 'Securitization'

Securitization is the process of converting a pool of assets, such as loans, into securities. This process allows for the diversification of risk and the transfer of credit risk from the originator of the loans to investors.

There are two main types of securitization: asset-backed securitization and mortgage-backed securitization. Asset-backed securitization involves the pooling of assets such as loans, leases, or receivables. Mortgage-backed securitization involves the pooling of mortgages.

The process of securitization begins with the originator of the loans, such as a bank or financial institution, selling the loans to a special purpose vehicle (SPV). The SPV then issues securities backed by the loans. These securities are sold to investors, who receive a return on their investment based on the cash flows from the underlying loans.

Securitization can be a complex process, but it can provide a number of benefits to both the originator of the loans and the investors. For the originator, securitization can help to reduce the risk of default on the loans and can provide a source of funding for new loans. For investors, securitization can offer a diversified investment opportunity with a relatively high return.

However, securitization can also be risky. If the underlying loans default, the investors in the securitized securities can lose their money. Additionally, securitization can contribute to systemic risk in the financial system. This is because when a large number of securitized securities are issued, it can be difficult for investors to assess the risk of the underlying loans. This can lead to a situation where investors are unaware of the risks they are taking on, which can ultimately lead to a financial crisis.

Despite the risks, securitization is an important part of the financial system. It provides a way for investors to diversify their portfolios and for originators of loans to obtain funding for new loans. However, it is important to be aware of the risks involved in securitization before investing in securitized securities.

In addition to the two main types of securitization mentioned above, there are also a number of other types of securitization, including:

* Collateralized debt obligations (CDOs): CDOs are a type of asset-backed security that is backed by a pool of debt instruments, such as bonds, loans, or receivables.
* Credit default swaps (CDSs): CDSs are a type of derivative that allows an investor to transfer the credit risk of a particular asset to another party.
* Structured investment vehicles (SIVs): SIVs are a type of investment vehicle that invests in a variety of assets, including securitized products.

Securitization is a complex and evolving financial process. It is important to understand the risks and benefits of securitization before investing in securitized products.

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