Normal spread, Financial Management

After the calculation of cash flow yield and the average life of the asset-backed and mortgage-backed security based on default, prepayment and recovery assumptions, the next thing to do is to compare the yield to a benchmark yield. Benchmark yield is the yield of treasury security which has the same maturity as the security's average life. Nominal spread is defined as the difference between cash flow yield and the yield of a comparable Treasury security. A normal spread has certain disadvantages. A part of nominal spread is compensation for accepting prepayment risk. Let us consider CMO support tranches that have been offered at a huge nominal spread. As we have seen earlier, nominal spread embodies substantial prepayment risk associated with support tranches. If a manager buys these CMO support tranches based on nominal spread, he will not succeed in determining whether or not the offered nominal spread is an adequate return given the substantial prepayment risk the support tranche holder has faced. Therefore, the manger should use measures like option-adjusted spread to indicate the potential compensation after adjusting for prepayment risk. 

Posted Date: 9/10/2012 8:09:52 AM | Location : United States







Related Discussions:- Normal spread, Assignment Help, Ask Question on Normal spread, Get Answer, Expert's Help, Normal spread Discussions

Write discussion on Normal spread
Your posts are moderated
Related Questions
In a fixed-rate coupon bond, the change in the price can be attributed to the change in the market interest rates. This change is due to the difference in the pre

Explain how the premium and discount are determined while assets are PTM (priced-to-market). When would the law of one price prevail in international capital markets although if fo

Inflation and Exchange Rates To understand the impact of inflation, several terms should be understood. For example, inflation from the investors' standpoint must be clearly de

I just purchased a stock that would pay the dividends of the first four years as D1 = $0.65, D2 = $0.74, D3 = $0.79, D4 = $0.84. I also told that the dividends would grow continual

What is the meaning of Financing decision Financing decision of a firm relates to choice of the proportion of these sources to finance investment requirements.

Q. What do you mean by Financial Leverage? Financial Leverage: - The financial leverage perhaps defined as the tendency of the residual net profit to vary disproportionately wi

What does it mean when we say that the correlation coefficient for two variables is -1? What does it mean if this value were zero? What does it mean if it were +1? Correlation is

What impact does high inflation have on the value of a business? Besides causing distortion (as it unequally affects all goods and services), inflation enhances the uncertainty

Q. Explain Risk Adjusted Discount Rate Method? In the risk adjusted discount rate method the future cash flow from capital projects are discount at the hazard adjusted discount

differentiate between pricing and allocative efficincy