In each case of the creation of MRSs, the cash flows from a pool of mortgages ar

Question

In each case of the creation of MRSs, the cash flows from a pool of mortgages are delivered, often rearranged in terms of amount and timing, to investors in the securities. No additional cash flows are added to the pool. Cash flows are available to investors come from the pool only. In fact, some cash flows are absorbed by the owners of the additional resources used to create the MRSs. Such parties as underwriters, investment bankers, trustees that hold the mortgages, security brokers, and their staffs absorb cash flows from mortgage pools. The question that presents itself is this: How can value be created through a system that does not add additional productive resources, but rather absorbs cash flows from the existing portfolio?

Explanation / Answer

MRS or mortgage related securities creates value by managing different types of risks - liquidity risks, interest rate risks, and credit risk. Liquidity risks arises when there are long term assets versus short term liabilities. Interest rate risks arise due to maturity mismatch. Credit risk may arise due to the risk associated with the cash flows.

MRS helps in transferring some risks from banks to the capital markets. This results in efficiency gains. Efficiency gains leads to creation of value.

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