High Finance

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High finance involves large scale financial transactions or institutions that play a major role in developing structured financial products, securitization of debt and introduction of new hedging and investing instruments. The basic benefits of high finance are that it enables companies and lenders to reduce their risk through the securitization of their assets and investors to diversify their investment portfolios.[br] Investors seek higher returns without facing the risk of bankruptcy and so invest in structured products.


High finance involves large scale financial transactions or institutions that play a major role in developing structured financial products, securitization of debt and introduction of new hedging and investing instruments. The basic benefits of high finance are that it enables companies and lenders to reduce their risk through the securitization of their assets and investors to diversify their investment portfolios.[br] Investors seek higher returns without facing the risk of bankruptcy and so invest in structured products. It also allows companies to raise large amount of funds through newer and more innovative instruments.

 

The development of structured products, such as asset backed securities or Collateralized Debt Obligations (CDOs), has played a key role in the growth of the financial markets. However, the excessive and inappropriate use of high finance techniques led to the credit bubble of the mid-2000s and the financial crisis of 2007-2009. 

High Finance Techniques

Structured Products and Securitization are the key techniques used by banks and lending institutions to restructure their balance sheets while continuing to expand their businesses. Some major types of structured products developed through the securitization of assets are:

Ø      Asset Backed Securities or ABS: These are securities collateralized by the cash flows derived from a pool of underlying assets that could be loans or any other receivables.

Ø      Mortgage Backed Securities or MBS: These securities are backed by the principal and the interest received from a set of mortgage loans. Collateralized Mortgage Obligations or CMOs are securitizations of mortgage backed securities.[br]

 

Ø      Collateralized Debt Obligations or CDOs: They are bonds issued in tranches with each tranche representing varying levels of risk.

Ø      Credit Derivatives: These are contracts used to transfer the risk of return on a credit asset falling below an agreed level, without actually transferring the underlying asset. Credit Default Swaps or CDSs are increasingly being used for hedging purposes.

Ø      Collateralized Fund Obligations or CFOs: They involve the securitization of private equity and hedge fund assets.

 

Another practice that expands the money supply in a system is the practice of Fractional Reserve Banking. As against the Full Reserve Banking practice which used to be followed in traditional days, Fractional Reserve Banking allows the banks to keep only a small portion of their deposits in reserve while lending out the remainder. The banks, however, retain the obligation to redeem all these deposits on demand.

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