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

Total cost of operating the business, Joe's ice cream stroe has to decide w...

Joe's ice cream stroe has to decide whether to shut down this winter or stay open. His projected revenue is $1,200 per week. He has fixed costs (Mortgage, taxes, insurance, etc.) t

Bond Valuation, The Pennington Corporation issued a new series of bonds on ...

The Pennington Corporation issued a new series of bonds on January 1, 1979. The bonds were sold at par ($1,000), have a 12 percent coupon, and mature in 30 years, on December 31,

182-day t-bills, 182-Day T-Bills Following the Sukhamoy Chakravarty Com...

182-Day T-Bills Following the Sukhamoy Chakravarty Committee recommendations, in November, 1986, 182-day T-bills were introduced in order to develop the short-term money market

Computing hedge ratio: the modified duration method, Let us consider a situ...

Let us consider a situation wherein a position in an interest rate dependent asset such as a bond portfolio or a money market security is hedged by using an interest ra

Analysis on the stocks, Yellow: is the company which their stock performanc...

Yellow: is the company which their stock performance was forecasted by analyst Blue: is the name of the company which made the recommendation by the analyst who work for it R

Role of special purpose vehicle, The financial institutions tha...

The financial institutions that originate the loans sell a pool of cashflow-producing assets to a specially created third party that is called a

Explain the operating profit margin - performance ratios, Operating profit ...

Operating profit margin Operating profit margin    =   (PBIT / Turnover) x 100% This is the ratio of operating profit to turnover or sales. A high operating profit margin is

Sally Thomson, Ask questionSally Thomson #Minimum 100 words accepted#

Ask questionSally Thomson #Minimum 100 words accepted#

Explain the time value of money, What is the time value of money? The m...

What is the time value of money? The meaning of time value of money is that money you hold in your hand today is worth much more than money you suppose to receive in the future

Assessing impact on management risk, Assessing Impact: As with the asse...

Assessing Impact: As with the assessment of likelihood, a valuable way of assessing impact would be the creation of categories of impact as follows: Level

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