Structured Finance – Investing in Structured Finance Requires Knowledge
When learning basic investing, most people can grasp the concept of a company’s equity and debt. They can also grasp the concept of leveraging the company’s equity with debt to finance expansion and other positive growth activities. However, when you throw the term “structured finance” into the mix the problems arise. Most people do not understand how structured finance allows a company or individual to leverage their equity.
The term structured finance is actually a broad one. It covers all sorts of financial arrangements where an investor attempts to increase profit by refinancing and hedging profitable economic activities. The many different types of financial instrument that can be utilized in structured financing make this a tantalizing area of investing. These types of financial arrangements can be quite profitable over time. However, they also pose a great deal of risk to the investor who is not careful.
Let’s look at a common example of structured finance to see how it works. When someone gets a mortgage to buy a new home or commercial building, that mortgage becomes an asset to the bank or lending institution to whom it belongs. However, it can pose a risk they do not want to carry for very long. They sell the mortgage for a price into a structured finance product.
The managers of the structured finance product take that mortgage and split its value among different claimants. So, if you have a $100,000 mortgage, the structured product may have 100 slices of that $100,000 mortgages in its mixture. Each slice has a different level of risk associated with it. The slices with lower risk will have lower profits given to the investor. The slices with higher risk have higher profits. This structure allows the mortgage investor to determine the acceptable level of risk they are willing to face.
The idea behind structured finance is to take a potentially risky investment and making it into something that offers safe investing opportunities for many. The structured finance products often contain different types of bond, loans, and other collateralized debt structures. Some structure products focus solely on one form of these debt structures. Others contain a mixture.
It is important to know what you are investing in before you make the leap into structured finance. The help of a financing expert is important unless you are experienced with this type of investment. You will be in a better position to make an informed decision after you speak with an expert.