Valuing mortgage-backed and asset-backed securities, Financial Management

  • A cash-flow yield is the discount rate that makes the price of a mortgage-backed or asset-backed security equal to the present value of its cash flows. It is built on three assumptions: i) assumption regarding prepayment and default recovery ii) assuming that the cash flows would be reinvested at the computed cash flow yield, and iii) the assumption that the security will be held by the investor until maturity. These three assumptions can also be considered as major drawbacks of this model.

  • The zero-volatility spread is a measure of the spread that the investor would realize over the entire Treasury spot rate curve if a mortgage-backed or asset-backed security is held to maturity.

  • The cash flows of mortgage-backed and asset-backed securities are interest rate path dependent; because of this feature, Monte Carlo method is used for valuing these securities instead of binomial model. Monte Carlo simulation is used for valuing mortgage-backed securities, while on-the-run treasury is used for valuing asset-backed securities. The simulation works by generating many scenarios of future interest rate paths. For each month, a monthly interest rate and a mortgage refinancing rate are generated. The monthly interest rates are used for discounting the projected cash flows and the mortgage refinancing rate is used for determining the cash flow because it represents the opportunity cost for the mortgagor.

  • A few duration measures that are used for mortgage-backed and asset-backed securities are effective duration, cash flow duration, coupon rate duration and empirical duration.

  • Basically, an asset-backed security can have one of the following three characteristics. (Characteristic a) No prepayment option. Example: security backed by credit card receivables. (Characteristic b) Prepayment option is available but borrowers do not show any intention of prepaying when refinancing rates fall below the loan rate. Example: security backed by automobile loans. (Characteristic c) Prepayment option is available and borrowers are willing to prepay when refinancing rates fall below the loan rate. Example: closed-end home equity loans taken by high quality borrowers. 

Posted Date: 9/10/2012 8:57:26 AM | Location : United States







Related Discussions:- Valuing mortgage-backed and asset-backed securities, Assignment Help, Ask Question on Valuing mortgage-backed and asset-backed securities, Get Answer, Expert's Help, Valuing mortgage-backed and asset-backed securities Discussions

Write discussion on Valuing mortgage-backed and asset-backed securities
Your posts are moderated
Related Questions
What is the Floating Rate Bonds (FRBs) Bonds whose interest payments fluctuate with changes in general level of interest rates and are tied to a basic rate (termed as the refer

Define Sources of risk with types???? how can we analysis the risk in bussiness?? plese help!!!!!

1. List the common elements of a submission for a major resource acquisition (purchase) 2. What is the difference between: A fixed asset and current asset? 3. If you worked i

Types of financial incentive schemes Performance associated pay (PRP) systems e.g. piecework or sales commission Bonuses e.g. supplementary payments for targets or ai


Discuss risk from the perspective of the Capital Asset Pricing Model (CAPM). The Capital Asset Pricing Model or CAPM be able to be used to compute the appropriate required rate

Q. Graphic Presentation of Net Operating Income Approach ? Graphic Presentation of NOI (Net Operating Income) Approach: - NOI (Net Operating Income) approach is explained graph

Aggregates Method Under the aggregates method of constructing an index number, we could have unweighted aggregates index and the weighted aggregates index. Unweighted Aggr

Why might it be very simple for an investor desiring to diversify his portfolio internationally to buy depository receipts as compared to the actual shares of the company? Answ

7. Bill Peters is the investment officer of a $60 million pension fund. He has become concerned about the big price swings that have occurred lately in the fund’s fixed income sec