Securitization is the process of transforming an illiquid asset into a security. Cash flow modeling is used in the valuation and analysis of securities. The model is a detailed picture that contains assets, investments, debts, income and expenditure. It is used in planning and forecasting the sources and use of the cash that has been used in the securitization process and the risk factors involved.
The securities that are created in a securitization process are usually credit enhanced as their credit quality is increased compared to the originators unsecured debts or the asset pool. The securities are split into tranches and each tranch has a different level of risk exposure.
The securities are often divided into classes where class A is the senior class of securities. The class A securities usually have the first claim of the cash that the SPV (Special Purpose Vehicle) receives .Class B and C are usually the protective layers of the A class. These classes receive payments after the senior class A. This is known as the cash flow model.
The model is cascading in nature and the priorities of payments are based on the hypothetical recession or a specific loss scenario. If the asset pool is not sufficient to make payments on the securities, the loss is first directed to the subordinated tranches B and C while the upper A tranches are unaffected by the losses.
In the securitized cash flow model, the lower securities bear the risks first in case there are any losses that may occur and therefore they receive lower credit ratings. These securities are not usually sold and hence only act as a cushion to the higher rated classes.
The cash flow model is based on assumptions on the prepayment, interest rates and recession simulation. For a free consultation please go to https://www.mortgageauditsonline.com/
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