Chapter 9

Investment, Speculation, and Hedging

Previous chapters have discussed the process of reallocating different risks among different groups of investors via the securitization of assets. For example, an asset such as a mortgage carries credit risk, prepayment risk, and interest-rate risk. A bank holding mortgages on its balance sheet absorbs the three risks. When these assets are securitized, risks can be redistributed among different groups of investors by “slicing and dicing” the cash flows, as well as slicing and dicing the credit risk from the underlying assets. This chapter highlights some of the investors’ concerns and provides some simple examples of strategies that have been developed to minimize or redistribute credit risk, interest-rate ...

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