Financial Risk Manager Part 1

Explanation

Securitization was particularly popular among money market and pension funds because it enabled them to invest in financial vehicles that they would normally not hold due to regulatory constraints. For example, they might have been allowed to invest only in AAA-rated fixed-income securities. Through securitization, they could now invest in the AAA-rated senior tranche of a portfolio consisting of BBB-rated securities. This allowed these institutions to diversify their portfolios and potentially achieve higher returns without violating regulatory requirements.

Why other options are incorrect:

• Choice B is incorrect: While securitized products can sometimes offer higher yields than corporate bonds, this is not always the case. It can depend on a wide range of factors including the credit quality of the underlying assets, the structure of the securitized product, the interest rate environment, and market conditions. Therefore, stating that they are more profitable as a rule is not accurate.

• Choice C is incorrect: Securitization does not allow funds to hold assets without disclosing such information in their balance sheet. In fact, regulatory requirements mandate that all financial institutions disclose their holdings in a transparent manner. Therefore, this cannot be the primary reason for these institutions' preference for securitized products.

• Choice D is incorrect: Although securitized products can be structured to reduce risk through diversification and tranching, they are not inherently less risky than traditional cash-generating assets like corporate bonds. The perceived riskiness of an asset depends on various factors such as credit quality and market volatility which may vary across different types of securities.