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Answer: Securitization increases the liquidity of the market by permitting the distribution of risk among a broad range of market participants.
## Explanation **D is correct** because securitization involves the originating entity assembling a pool of similar loans and using that pool as collateral for new securities. This process: - Uses an "originate-to-distribute" strategy where firms originate loans with the intent to securitize rather than hold them on their balance sheet - Reduces the originating entity's risks by: - Eliminating credit risk (originating entity doesn't own the collateral) - Removing price risk (originating entity doesn't own individual assets in the pool) - Eliminating liquidity risk (illiquid loans become liquid securities) - Spreads risk among a broad range of investors in the securities **A is incorrect** because securitization is not exclusive to financial institutions. Manufacturing companies and other non-financial corporations also use securitization as a risk management tool and funding mechanism. **B is incorrect** because the originate-to-distribute model actually creates moral hazard by reducing lenders' incentives to maintain high underwriting standards and monitor borrower creditworthiness. **C is incorrect** because credit derivatives and securitization have different structures. Credit derivatives transfer credit risk between counterparties without selling the underlying position, while securitization involves pooling assets and creating new securities backed by those assets.
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An investment manager at a large investment bank is developing a new MBS product to offer to the bank's clients. The manager asks an analyst to conduct a thorough analysis of the different types of MBS available in the market and the securitization process used to create these products. Which of the following is correct for the analyst to conclude about securitization after the analysis?
A
Securitization is a practice used exclusively by financial institutions to remove assets from their balance sheets.
B
The securitization process is designed to prevent moral hazard from arising in the loan underwriting process.
C
Securitized products and credit derivatives share the same structure of pooling assets and repackaging them into interest-bearing securities.
D
Securitization increases the liquidity of the market by permitting the distribution of risk among a broad range of market participants.