Synthetic investment

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Synthetic Investment

A combination of investment vehicles that, when used together, can create a profit. An example is an option spread, where one takes two or more positions in option contracts in order to profit from the difference in their prices. Likewise, one may create a synthetic index in order to outperform a real index. Institutional investors are the main creators of synthetic investments.

Synthetic investment.

A synthetic investment simulates the return of an actual investment, but the return is actually created by using a combination of financial instruments, such as options contracts or an equity index and debt securities, rather than a single conventional investment.

For example, an investment firm might create a synthetic index that seeks to outperform a particular index by purchasing options contracts rather than the equities the actual index owns, and using the money it saves to buy cash equivalents or other debt securities to enhance its return on the derivatives.

Options spreads, structured products, and certain investments in real estate and guaranteed investment contracts can be described as synthetic products.

While they are artificial, they can play a legitimate role in an individual or institutional investor's portfolio as a way to reduce risk, increase diversification, enjoy a stronger return, or meet needs that conventional investments don't satisfy.

However, synthetic investments may carry added fees and add more complexity than you are comfortable dealing with.

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The Treasury, the Federal Reserve Board and the Federal Reserve Bank of New York became involved with AIG in September 2008 when a unit of AIG's holding company, AIG Financial Products, had issued credit default swaps on what was later learned to be $2.77 trillion of securities and synthetic securities backed by mortgages of varying quality.
(143) Predictably, German originators with synthetic securities purchase credit default protection in the form of credit default swaps, for instance, from protection sellers, thus fitting with our overall understanding of synthetic securities transactions.
More generally, the current financial climate might make banks hostile to the idea of keeping a collection of mortgages on their balance sheets as synthetic securities for which they have to purchase credit default swaps.
"What's going to continue to drive the markets are the anecdotal-like news coming from financial institutions on problems with all these synthetic securities that have been developed by Wall Street," said Johnson Illington Advisors chief investment officer Hugh Johnson.
In three sections covering fixed income securities, corporate debt markets, and structured financial products, he discusses the basics, forms of instruments, the yield curve, hybrid securities, callable and convertible bonds, the Eurobond market, warrants, preference shares and preferred stocks, mortgage and asset- backed securities, covered bonds, synthetic securities, collateralized debt obligations, index-linked derivatives, and relative value analysis.
This is accomplished either directly through the sale of assets oft the institution's balance sheet to the CDO, or by transferring the risk to the CDO through the use of synthetic securities. The sponsoring institution typically has retained all or a portion of the equity interest as a means of increasing return on equity.
It is an excellent summary of some of the main analytical considerations in explaining the origins and structure of securitization, how securitization adds value, the basic requirements for securitization, and how synthetic securities and related derivatives are created.
For example, the portfolio might include bonds, loans or synthetic securities, corporate securities, structured finance securities, assets denominated in U.S.
* Buckets for assets such as structured finance securities, synthetic securities, and guaranteed securities;
Application of defaults to synthetic securities in CDOs is the same as for synthetic CDO structure and includes publicly documented rescheduling.
Many traditional cash flow CDO structures allow for the purchase of synthetic securities as eligible collateral.
This section substantively restates the swap criteria for structured finance transactions that were originally published in Standard & Poor's 1995 publication Global Synthetic Securities Criteria.