Part 1: Please respond to the following:
- From the e-Activity Part 1, critics have suggested that the complexity inherent in securitization can limit investors’ ability to monitor risk. Evaluate the merits of this criticism, indicating your agreement or disagreement with the criticism. Provide support for your position.
- Mortgage-backed securities are believed to have contributed to the recent subprime mortgage crisis. Assess the fairness of this statement, providing a rationale for your reasoning and a recommendation for future use of this type of investment.
- Please provide one citation/reference for your initial posting that is not your textbook. Please do not use Investopedia or Wikipedia.
- *** Double-Space is not necessary ***
- *** 150 + Words ***
Part 2: Respond to classmate’s discussion below:
“It can be said that Mortgage-backed security is the reason for the recent subprime mortgage crisis. Securitization can be described as a grouping of the assets and then transforming it into a security. In this method, pooled assets can be bought by an investor in return for the cash flows from the safe. The investor has a choice to obtain the tranche of his or her choice. It depends on the level of risk the investor can bear.
Tranches can be described as the pieces of pooled assets, which is distinguished by its risk and other characteristics. The return on junior tranche is high, but the risk associated with it is also high. Senior tranche is considered as a safe investment with low yield and low risk.
Thus, it can be said that securitization is a complex process, but an investor can still monitor the risk. So, this statement is not correct.
In mortgage-backed security (MBS), the bank pools the home loan and then sell them at a discount to the investor. It can be said that MBS was responsible for the recent subprime mortgage crisis. Subprime mortgages increased during the period of crises. The price of houses was also declining during that period. Thus, most of the borrowers of subprime mortgages defaulted on their loans. Most of the mortgage-backed securities were with an underlying pool of these subprime mortgages, which were defaulted. This results in the collapse of the entire credit market, which leads to the financial crisis.”