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

Conversion ratio, It is the number that tells how many common stock...

It is the number that tells how many common stocks (or preference stocks) will the bondholder receive at the time of conversion. It is usually constant over

Explain continuous compounding benefit an investor, How does continuous com...

How does continuous compounding benefit an investor? The influence of increasing the number of compounding periods every year is to increase the future value of the investment. Th

Strategic management, Develop and implement strategic plan using bounce fit...

Develop and implement strategic plan using bounce fitness as case study

Equity, how do we measure equity in an orgarnisation

how do we measure equity in an orgarnisation

External financing with same cost of capital, External Financing with Same ...

External Financing with Same Cost of Capital and Same Proportions as Existing: If a firm raises new capital funds in the same proportion as at present and at the same specific cos

Market segmentation of the term structure of interest rates, Define the mar...

Define the market segmentation of the term structure of interest rates. Market segmentation: And also the investors’ expectations regarding future interest rates and thei

Describe working capital decision, Q. Describe Working Capital Decision? ...

Q. Describe Working Capital Decision? Working Capital Decision: - It is anxious with the management of current assets. It is a significant function of financial management. Cur

Based on Anthony''s Orchard financial data, Question #1: Review the Anthon...

Question #1: Review the Anthony’s Orchard case study in the unit resources. Consider the following assumptions: • The company, according to Anthony’s Orchard Strategic Plan, is h

Incremental cost, Incremental Cost The measured change in a firm's cos...

Incremental Cost The measured change in a firm's cost of production due to an additional activity pursued by the firm. Incremental costs can be measured by the cost difference

Short sales, Short sales  : Short sales of a security means borrowing o...

Short sales  : Short sales of a security means borrowing of an underlying security by an investor from other investors who are holding it (in Demat account) and selling it with

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