Definition
A Structured Investment Vehicle (SIV) is a type of investment fund that borrows money by issuing short-term securities at low interest rates and then lends that money by buying long-term securities at higher interest rates, making profit from the difference. These vehicles are typically established as off-balance sheet entities by financial institutions. The purchased securities often include mortgages, credit card debts, and auto loans.
Key Takeaways
- A Structured Investment Vehicle (SIV) is a type of fund that borrows money by issuing short-term securities at low interest rates and then lends that money by purchasing long-term securities at higher interest rates, ultimately making a profit from the interest rate differential.
- SIVs are typically operated by international banks or investment firms. The operators manage them off-balance sheet, meaning their assets and liabilities are not included in the firm’s financial statements to limit direct exposure to credit risks.
- Though potentially profitable, SIVs can pose high risks. During a market downturn, SIVs can face serious challenges since the value of their assets can abruptly fall, impacting their ability to meet short term debt obligations. Their role in the 2008 financial crisis highlighted these risks and led to tighter regulations of such entities.
Importance
Structured Investment Vehicles (SIVs) are an important term in finance as they play a crucial role in offering substantial liquidity and credit management in the financial markets.
These off-balance-sheet entities allow investment banks and financial institutions to invest in assets, especially long-term assets, while issuing short-term securities.
By strategically being involved in both long-term and short-term investments, SIVs promote risk diversification and offer potentially higher returns.
However, it’s crucial to note that they also contributed to the 2008 financial crisis due to their investment in high-risk mortgage-backed securities, hence, their operations, along with the associated risks, significantly influence the stability and function of global financial markets.
Explanation
A Structured Investment Vehicle (SIV) is a complex financial tool that businesses, particularly those in the sector of finance, use for various investment purposes. The core purpose of an SIV is to generate profit from the discrepancies in the credit spreads between short-term debt and long-term structured finance products.
These vehicles operate by issuing short-term securities at low interest rates and then utilizing the raised money to invest in long-term securities at high-interest rates. The difference in the earned long-term interest and the paid short-term interest becomes the profit or income for the entity running the SIV.
Furthermore, Structured Investment Vehicles are used for off-balance-sheet investments, which means the liabilities and assets of the SIV are not reflected on the balance sheet of the parent company. By keeping investments off the balance sheet, businesses can invest in high-risk instruments without impacting their overall financial health or credit rating, should the investment not yield expected returns.
Essentially, SIVs provide financial institutions a way to engage in more speculative, higher risk investments while limiting their exposure to potential losses.
Examples of Structured Investment Vehicle
Cheyne Finance – Cheyne Finance was a structured investment vehicle (SIV) set up by Cheyne Capital Management (UK) LLP in
It invested in numerous high-rated securities and created profit from the spread between the interest it earned on its assets and the lower interest it paid on its short-term debt.
Sigma Finance – This was a structured investment vehicle operated by Sigma Finance Corporation. Up until the financial crisis of 2008, Sigma had successfully borrowed short-term capital to invest in higher-yielding, long-term debt, generating substantial profits. However, the reduced credit availability after the crisis led to its inability to rollover debt and eventually caused Sigma Finance to collapse.
Rhinebridge – In July 2007, the German IKB Deutsche Industriebank launched Rhinebridge, an off-balance-sheet SIV. Capitalizing on the positive spread between high rated long term investments and the short-term debt, Rhinebridge was able to gain profits. However, with the onslaught of the financial crisis, the value of assets plummeted and the vehicle was unable to secure short-term funding, leading to its collapse. These are only a few examples of a much larger issue that contributed to the financial crisis of 2007-
Many financial institutions adopted similar strategies, involving high-risk investments funded by short-term borrowings, leading to a wave of defaults when the market conditions changed.
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FAQs on Structured Investment Vehicle
What is a Structured Investment Vehicle?
A Structured Investment Vehicle (SIV) is a pool of investment assets that attempts to profit from credit spreads between short-term debt and long-term structured finance products. These vehicles are similar to Conduits, which are also pools of assets.
How do Structured Investment Vehicles work?
SIVs work by selling short-term securities to investors, such as Commercial Paper and Medium Term Notes, and using the proceeds to buy longer term securities. The profit is earned from the spread between the incoming cash flows (long-term assets) and the outgoing cash flows (short-term liabilities).
What are the risks associated with Structured Investment Vehicle?
The main risks associated with SIVs are liquidity risk and credit risk. Liquidity risk is the risk that the SIV will not be able to meet its financial obligations as they come due, while credit risk is the risk that the SIV’s credit assets will be downgraded, which would reduce the value of the Security.
What is the role of a Structured Investment Vehicle in finance?
SIVs plays a crucial role in the financial markets. They provide liquidity to the market by buying long-term assets and funding them by issuing short-term liabilities. In return, they earn the spread between the two.
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Related Entrepreneurship Terms
- Off-Balance Sheet Entity
- Special Purpose Vehicle (SPV)
- Asset-Backed Securities (ABS)
- Securitization
- Debt Instruments
Sources for More Information
- Investopedia: A comprehensive online resource devoted to educating individuals about various aspects of finance including structured investment vehicles.
- The Federal Reserve: The central bank of the United States, this institution offers plenty of educational resources about different financial mechanisms.
- MarketWatch: A website that provides financial information, business news, analysis, and stock market data.
- Financial Times: A British international daily newspaper printed in broadsheet and published digitally that focuses on business and economic current affairs.
