Use of Interest Rate Derivatives in Securitization Transactions

Abstract

In this article, the authors review the use of interest rate derivatives in securitization transactions for hedging and yield enhancement. Three types of interest rate derivatives commonly used in securitizations are interest rate swaps, interest rate caps, and interest rate corridors. Because these derivatives are over-the-counter or dealer products, not exchange-traded products, they expose the trust to counterparty risk. The authors discuss how counterparty risk is managed in securitizations, including the use of a rating trigger and methods for determining swap termination payments.