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
Question: The stock of Bax Limited performs relatively well to other stocks during recessionary periods. The stock of Pax Limited, on the other hand, does well during growth

What is Marginal cost of capital Marginal cost of capital, by contrast refers to incrementalcost associated with new funds raised by firm. Marginal cost is the specific conc

Q. What is Maturity? Maturity: The maturity period of the securities should be short, otherwise, the company might suffer losses on account of getting the funds pre-maturely re

Types of equaty Securities Equity securities, traditionally, are classified into two types when they are issued. They are: Common Stock, and Preferred Stock.     Common Stoc

Forms of Regulation There are different forms of regulation to regulate market to fulfill certain objectives. These are discussed below: Disclosure Regulation The whole

Why does money have time value? Positive interest rates point out that money has time value.  While one person lets another borrow money, the first person needs compensation in e

There are some misconceptions about securitization: Poor quality originators end up in securitizing their assets. A bank's best mortgage

Explain in brief about Financial management These tools help the manager to figure out which sources offer the lowest cost offunds and which activities will provide the greates


Describe your role in managing a discrete assignment