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
Blossom Lawn expects to have total sales next year totaling $15,000,000 and the firm pays taxes at 35% and will owe $300,000 in interest expenses.

A firm has sales of $6,500, net income of $500, total assets of $12,000, and total equity of $700. Interest expense is $1000. What will be the common-size statement value of the in

Depository institutions Depository institutions: intermediaries with a important proportion of their funds derived from customer deposits - include commercial banks - savings i

Suppose the government wants to increase farmers’ incomes.  Why do price supports or acreage limitation programs cost society more than simply giving farmers money? Price acrea

European Community (EC) An economic alliance, evaluated in 1957, designed to encourage trade and economic cooperation between its members.  The EC is also called the European

Q. Causes of Risks 1) Wrong decision of what to invest in. 2) Wrong timing of investments. 3) Nature of instruments invested such as shares or bonds, chit funds, benefit

Describe the balance of payments identity and discuss its implications under the fixed and flexible exchange rate regimes. Answer:  The balance of payments recognize holds that t

Basics of Convertible Bonds The provision of conversion in a corporate bond entitles the bondholder the right to convert the bond into a predetermined number of shares of commo

The price charged when one segment of an organization provides goods or services to another segment of the organization.

Borrowing Funds to Purchase Bonds There are several sources available to borrow funds. When securities are purchased with borrowed funds then the mo