Structured Investment Vehicle (SIV)

Structured Investment Vehicle SIV Arbitrage Fund Asset-Backed Commercial Paper Medium-Term Notes Asset-Backed Securities Financial Crisis
A type of arbitrage fund that finances its operations through the sale of asset-backed commercial paper and medium-term notes, investing primarily in asset-backed securities.
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Structured Investment Vehicle (SIV)

Definition

A Structured Investment Vehicle (SIV) is an arbitrage fund that raises financing by issuing short-term debt in the form of asset-backed commercial paper (CP) and medium-term notes, and then investing these proceeds in longer-term asset-backed securities (ABS). The primary aim of an SIV is to profit from the spread between the lower short-term interest rates paid to commercial paper holders and higher returns earned from the ABS investments.

Examples

  1. Sigma Finance Corporation: Sigma was one of the largest SIVs, structured to invest in diverse asset-backed securities, aiming to achieve high credit ratings for the issued commercial paper.
  2. Cheyne Finance: This SIV issued commercial paper to fund its ABS investments, but collapsed during the financial crisis when liquidity dried up.
  3. Orion Finance: Similar to other SIVs, Orion Finance arbitraged its short-term funding cost against the yields on its longer-term ABS investments, eventually facing liquidity issues during the economic downturn of 2008.

Frequently Asked Questions (FAQs)

Q1: What is an SIV and how does it operate?

A1: A Structured Investment Vehicle (SIV) is an arbitrage fund that operates by issuing short-term debt instruments like asset-backed commercial paper and medium-term notes. It uses the raised capital to invest in longer-term asset-backed securities, making a profit from the interest rate differential between the short-term debt and long-term investments.

Q2: Why did most SIVs fail during the global financial crisis?

A2: SIVs failed during the global financial crisis due to a severe liquidity crunch. The market for asset-backed commercial paper dried up, causing a liquidity mismatch as SIVs couldn’t roll over their short-term debt or sell their ABS investments quickly enough.

Q3: What’s the difference between an SIV and a traditional investment fund?

A3: An SIV differs from traditional investment funds in its structure and operations. It focuses on short-term funding through CP and medium-term notes, aiming to exploit interest rate differentials between such funding and ABS investments. Traditional funds generally do not rely on maturity transformation to this extent.

  1. Arbitrage: A trading strategy that seeks to profit from price discrepancies in different markets or forms of a particular financial instrument.
  2. Commercial Paper (CP): A short-term unsecured debt instrument issued by corporations to finance their short-term liabilities.
  3. Medium-Term Notes (MTNs): Debt instruments with maturity periods ranging from one to ten years, issued by corporations to fund longer-term needs.
  4. Asset-Backed Securities (ABS): Financial securities backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities.

Online References and Resources

  1. Investopedia: Structured Investment Vehicle (SIV)
  2. Moody’s Investors Service on SIVs
  3. U.S. Securities and Exchange Commission (SEC)

Suggested Books for Further Study

  1. “Structured Finance: A Guide to the Principles of Asset Securitization” by Steven Schwarcz et al.
  2. “The Securitization Markets Handbook: Structures and Dynamics of Mortgage- and Asset-Backed Securities” by Charles Austin Stone and Anne Zissu.
  3. “Asset Securitization: Theory and Practice” by Joseph Hu.

Accounting Basics: “Structured Investment Vehicle (SIV)” Fundamentals Quiz

### What is the main purpose of a Structured Investment Vehicle? - [ ] To issue permanent equity to investors. - [ ] To invest in stocks and bonds. - [x] To profit from the interest rate spread between short-term debt and long-term assets. - [ ] To operate as a retail bank. > **Explanation:** An SIV aims to profit from the interest rate differential between the short-term debt issued and the higher returns from long-term asset-backed securities. ### What instruments do SIVs primarily use to raise funds? - [ ] Corporate Bonds - [x] Asset-Backed Commercial Paper (CP) and Medium-Term Notes (MTNs) - [ ] Equity Shares - [ ] Long-Term Loans > **Explanation:** SIVs raise funds by issuing asset-backed commercial paper and medium-term notes. ### Which type of asset do SIVs typically invest in to make profits? - [ ] Government Bonds - [ ] Mutual Funds - [ ] Real Estate - [x] Asset-Backed Securities (ABS) > **Explanation:** SIVs invest the raised capital into asset-backed securities (ABS) to make profits from the interest rate spread. ### Why did most SIVs fail during the global financial crisis? - [ ] Changes in stock market regulations. - [ ] Rise in real estate values. - [x] Severe liquidity crunch and inability to rollover short-term debt. - [ ] Increased competition in investment funds. > **Explanation:** Most SIVs failed due to a severe liquidity crunch, which made it difficult to rollover short-term debt or sell ABS investments during the crisis. ### What kind of liquidity issue did SIVs face during the financial crisis? - [x] Inability to roll over debt - [ ] High demand for commercial paper - [ ] Decrease in ABS yields - [ ] Redundancy of short-term notes > **Explanation:** SIVs faced an inability to roll over debt during the crisis as liquidity dried up in the commercial paper market. ### How is the profit mechanism of an SIV primarily described? - [ ] By offering services at lower costs. - [ ] Through dividend payments. - [x] Arbitrage between short-term borrowing costs and long-term investment returns. - [ ] By issuing equity shares. > **Explanation:** SIVs profit through arbitrage between the costs of short-term borrowing and returns from long-term investments. ### What are the typical maturity periods for Medium-Term Notes (MTNs)? - [ ] Less than one year - [ ] More than ten years - [x] One to ten years - [ ] Three months > **Explanation:** Medium-Term Notes (MTNs) have maturity periods ranging from one to ten years. ### Which financial market problem directly affected SIVs during the 2008 crisis? - [ ] Stock market crash - [ ] Hyperinflation - [ ] Real estate bubble burst - [x] Liquidity crisis in the CP market > **Explanation:** The liquidity crisis in the commercial paper market directly affected the ability of SIVs to continue operations. ### Which term best describes the strategy of an SIV? - [ ] Market speculation - [ ] Capital restructuring - [x] Arbitrage - [ ] Venture capital > **Explanation:** SIVs operate on an arbitrage strategy, aiming to profit from differences in interest rates. ### Who would be the primary regulatory body for reviewing structured investment vehicles in the US? - [ ] Federal Reserve - [x] U.S. Securities and Exchange Commission (SEC) - [ ] Treasury Department - [ ] IRS > **Explanation:** The U.S. Securities and Exchange Commission (SEC) reviews and regulates entities that issue structured financial products, including SIVs.

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