Amortizing/non-amortizing assets, Financial Management

Assignment Help:

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.


Related Discussions:- Amortizing/non-amortizing assets

Determine about the entity level - inherent risk, At entity level - Inheren...

At entity level - Inherent risk Integrity of management. Management's experience and knowledge Over reliance on key customers. Unusual pressures on management

Describe the benefits of wealth maximisation criterion, Describe the benefi...

Describe the benefits of Wealth maximisation criterion Value of an asset must be viewed in terms of the benefits it can produce. Worth of a course of action can similarly be ju

Sovereign bonds, There are two major factors to be considered while a...

There are two major factors to be considered while analyzing sovereign bonds. They are: economic risk and political risk. Economic risk is all about the ability a

LP Problem, Max Z = 107x1+x2+2x3 Subject to 14x1+x2-6x3+3x4=7 16x1+x2-6x3...

Max Z = 107x1+x2+2x3 Subject to 14x1+x2-6x3+3x4=7 16x1+x2-6x3 3x1-x2-x3 x1,x2,x3,x4 >=0

Explain about the internal controls of benchmarking, Explain about the Inte...

Explain about the Internal controls of benchmarking   "Comprises control environment and control procedures. It includes all the procedures (internal contr

Commercial paper, Commercial Paper (CP) is a short-term unsecured pro...

Commercial Paper (CP) is a short-term unsecured promissory note issued in the open market. It also represents the obligation of the issuer. Normally, it is issued

What are the operating and financing decisions of any firm, A firm's operat...

A firm's operating and financing decisions   Risk also results from decisions made within the company.  This risk is usually divided into two classes:  - Business risk is th

How to measure the firm risk of a capital budgeting project, Explain how to...

Explain how to measure the firm risk of a capital budgeting project. The firm risk of a capital budgeting project measures the force of adding a new project to the existing pro

Weighted average cost of capital, Weighted Average Cost of Capital Wei...

Weighted Average Cost of Capital Weighted average cost of capital is the average cost of the costs of several sources of financing. Weighted average cost of capital is also kn

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd