Amortizing/non-amortizing assets, Financial Management

The asset that acts as a collateral for an asset-backed security can either be an amortizing or a non-amortizing asset. In an amortizing asset, the loan repayment (consisting of the capital and interest) is distributed over the life of the loan. The pattern of periodic repayment of principal is referred to as amortization schedule. Mortgage loans taken for construction of houses are a form of amortizing asset. If any amount in excess of scheduled repayment of principal is made, then it is termed prepayment. Prepayment can be made partially or in entirety.

Non-amortizing assets do not have a particular fixed pattern of payment of interest and repayment of principal. However, a minimum periodic payment is mandatory in the case of non-amortizing assets. If the minimum periodic payment is less than the interest on the outstanding loan balance, then the difference between the two is added to the outstanding loan balance. Similarly, if the amount that is payable is greater than the interest on the outstanding loan balance, the excess amount is reduced from the outstanding loan balance. Here, there is no schedule of principal repayment. Examples of non-amortizing assets include credit card receivables and some forms of home equity loans.

In order to determine the cash flows associated with an amortizing asset, the first step required is to project the prepayments involved. What triggers prepayment? Why will a borrower go in for prepayments? Prepayment is resorted to by the borrower when the interest rates that prevail in the market are lower than the rate on the loan. But it may not be always true that the borrowers will take full advantage of the decline in interest rate below the rate on the loan. So, it is required to assess the extent to which the borrower will resort to prepayment.

Another issue that needs special attention while projecting the cash flows is the default possibility. The amount that is recovered on default by the sale of the asset before the scheduled repayment date is also a form of prepayment and is called involuntary prepayment. This requires an assumption about the default rate and the recovery rate. Though there is no prepayment in the case of non-amortizing assets, default is possible and hence projections of default rate and recovery rate are required.

Prepayments can be analyzed in two ways viz.,

  1. Pool-level analysis.

  2. Loan-level analysis.

In pool-level analysis, all loans comprising the collateral are assumed to be identical. In loan-level analysis, each loan is amortized individually.

Posted Date: 9/8/2012 9:04:50 AM | Location : United States







Related Discussions:- Amortizing/non-amortizing assets, Assignment Help, Ask Question on Amortizing/non-amortizing assets, Get Answer, Expert's Help, Amortizing/non-amortizing assets Discussions

Write discussion on Amortizing/non-amortizing assets
Your posts are moderated
Related Questions
DISCOUNTING TECHNIQUE is also called present value technique. It is the process of calculating the present value of cash flows.  Discounting is determining the present value of a

Monitoring and Controlling Budgets: The preparation of budgets is only part of the budget cycle.  Once set, an organisation should actively monitor actual revenue and expenditu

Active bond management depends on an economic scenario in order to forecast the movements of yield curve. A portfolio manager skillfully builds a portfolio wit

Meaning of Returns The return from holding an investment over some period - say, a year, is simply any cash payments received due to ownership, plus the change in market price,

Mount Hutt Ltd. just paid dividend of $2.20 per share. The dividends are expected to grow at a constant rate of 4% per year, indefinitely. If investors require an 11% return on Mou

Country analysis and political risk Country analysis could use tools for example PEST factors in order to strategically analyse countries. Political risk

Duration is good measure while estimating the percentage price change for a small change in interest rates but the estimation becomes inferior with the larger cha

What is the role of investment banking in investment intermediaries? Investment banks: These banks assist corporations or governments into the issue of new debt or equity

Product development A strategy which tends to increase sales by the development of new services or products to the same market for example an entirely new or improved existing

Discuss the relationship between financial decision making and risk and return. Would all financial managers view risk-return tradeoffs similarly