Structured Investment Vehicles (SIV)

Structured investment vehicles are a type of investment that took a lot of scrutiny during the market downturn of 2008. The structured investment vehicle is a type of investment that is offered by investment banks and other financial institutions. The idea behind this type of investment is that the financial institution is going to sell short-term commercial paper to start out with. They will sell this type of security so that they can generate a large amount of cash. With the money that is generated from the short-term commercial paper, the company will then invest in long-term instruments such as corporate bonds. Here are the basics of structured investment vehicles and how they work.

Structured Investment Vehicle

The interest rates of the long-term bonds are going to be higher than the interest rates of the short-term commercial paper. The difference between the two interest rate is going to be considered profit for the investors. They will use the money that is generated from the bonds to pay for the payments associated with repaying the commercial paper.

Slim Margin

This type of investment carries with it a very slim margin for error. Typically, whenever you are investing in these two types of securities, there is less than one percent difference in the rates of return. In most cases, the investment manager is only looking for a difference of .25 percent or more. This .25 percent represents the profit from the investment. 

Risks

Structured investment vehicles carry with them a certain amount of risk. One source of risk comes from the fact that the long-term securities might lose value, when compared to the short-term investments. If this happens, you are essentially paying a higher rate of interest than you are bringing in. This can be disastrous because you would be losing money on the investment.

The other type of risk involves dealing with the payments. Since you are taking on a short-term debt in order to purchase long-term debt, the short-term debt is going to come due sooner. This means that you will have to be able to take the interest payments that are made from the long-term debt to repay the short-term debt. If things do not work out, the investment money might have a big problem on their hands when it comes to paying their debts.

Another problem that these types of investments deal with is the credit approval. For example, whenever a lender is making a commercial loan, they typically spend a great deal of time analyzing the company of loan recipients. By doing this, they will be able to choose companies that have a low credit risk. However, when the lenders know that they can simply sell the loans off to structured investment vehicles, they will not spend as much time analyzing the risk of the companies. This creates a scenario where the portfolio of loans that were purchased by the structured investment vehicle are substandard. 

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