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Consider the market for a bond. Smart investor figured out that the default risk on the bond is lower then we thought. More people find out and there's a lot of

Consider the market for a bond. Smart investor figured out that the default risk on the bond is lower then we thought. More people find out and there's a lot of demand for the bond so the price goes up. Now the bond trades above face value, so new investors get a lower % return, and the bond is no longer a good deal, so the price stops rising. The same issue holds true for stocks, which are also valued based on a claim for some predicted future cash flows.

pertymcpert 8y ago
Yes, and for anyone interested your second paragraph is the definition of a “security”.
- csomar 8y ago
  I thought that is the definition of an "asset" which is a broader term.
  - PakG1 8y ago
    Assets cannot by themselves generate future cash flows. If a house just sits there, it cannot generate cash flows, it needs a tenant to do that. A hundred dollar bill cannot generate cash flows by sitting under your pillow. It needs to be put to work to generate cash flows. Assets can be used to generate cash flows, but they cannot generate cash flows just by existing. Hence the difference between asset and security, though both can be ascribed to have value.
    - evrydayhustling 8y ago
      Securitization is about ease of trading - which is helped by but not defined by ease of collecting cash flows. An asset is exactly something that can generate future cashflows, even if only by being sold. A security is a special kind of asset that can be easily traded on paper without changing it's value or taking on transformative effort. So, your goose that lays golden eggs is indeed an asset, but it might be hard to trade because many folks aren't well prepared to own a giose. If you wrap it up in contracts about someone who will house and feed the goose, collect and sell the eggs and forward the money to the holder of a deed - congrats, that deed is now a security.
- winningcontinue 8y ago
  the definition of a security has nothing to do with how they're valued.

pertymcpert 8y ago

Yes, and for anyone interested your second paragraph is the definition of a “security”.

csomar 8y ago
I thought that is the definition of an "asset" which is a broader term.
- PakG1 8y ago
  Assets cannot by themselves generate future cash flows. If a house just sits there, it cannot generate cash flows, it needs a tenant to do that. A hundred dollar bill cannot generate cash flows by sitting under your pillow. It needs to be put to work to generate cash flows. Assets can be used to generate cash flows, but they cannot generate cash flows just by existing. Hence the difference between asset and security, though both can be ascribed to have value.
  - evrydayhustling 8y ago
    Securitization is about ease of trading - which is helped by but not defined by ease of collecting cash flows. An asset is exactly something that can generate future cashflows, even if only by being sold. A security is a special kind of asset that can be easily traded on paper without changing it's value or taking on transformative effort. So, your goose that lays golden eggs is indeed an asset, but it might be hard to trade because many folks aren't well prepared to own a giose. If you wrap it up in contracts about someone who will house and feed the goose, collect and sell the eggs and forward the money to the holder of a deed - congrats, that deed is now a security.
winningcontinue 8y ago
the definition of a security has nothing to do with how they're valued.