Question

a) Why is a special purpose vehicle used to own the loans and issue securities in a securitization transaction?

b) How would an interest rate derivative be used to address the interest cash flow mismatch in a securitization consisting of fixed rate loans in which floating rate securities are used?

Answer 1

Special purpose vehicle is used to isolate the asset and carry it off balance sheet of the parent company.

Suppose say a company want to carry out the project and wants to raise the money for the same purpose now the company will want that the risk associated with the project should not harm the entire company as a whole for this purpose special purpose vehicles are made. SPVs isolate the risk associated with the project and secure the parent company as they can raise the loan and issue securities in a securitization transaction if the project is in loss then also parent company will be isolated from the transaction and hence it is also called " Bankruptcy Remote Entity".