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

Yield spread strategies, Bond market can be classified into various s...

Bond market can be classified into various segments based on the nature of characteristics such as type of issuer (central bank, corporate etc.), credit risk (ris

How foreign subsidiary’s financial structure become relevant, Under what ci...

Under what circumstances will the foreign subsidiary’s financial structure become relevant? The subsidiary’s own financial structure will become applicable when the parent firm

Empirical measurement of liquidity, Empirical Measurement of Liquidity: Th...

Empirical Measurement of Liquidity: The number of days a particular share is being traded reflects the liquidity of the market. If it is traded actively on 50% of the days when th

Advent of euro affect international diversification strategy, Explain how t...

Explain how the advent of the euro would affect international diversification strategies. Answer: As the euro-zone will have similar exchange-rate policies and monetary, the co

Conservative approach of financial management, Q. Conservative Approach of ...

Q. Conservative Approach of Financial Management? An exact matching plan may not be followed in practice. A firm may adopt a conservative approach in financing its current and

Minimum bonus and maximum bonus, Question 1 Sections 42 to 50 of the Act d...

Question 1 Sections 42 to 50 of the Act deal with provisions pertaining to welfare of workers. State a few welfare measures that you would suggest in factories. List the welfare m

Convertible and non-convertible bonds, Bonds can also be classified i...

Bonds can also be classified into convertible and non-convertible depending upon whether they carry a conversion feature or not. Convertible bonds are the ones which ca

Time value of money, TIME VALUE OF MONEY Time value of money can be de...

TIME VALUE OF MONEY Time value of money can be described as the value of a unit of money at different time periods.  It involves that the value of a unit of money is not same

Financial mangement enviroment, 1. role financial intermediaries 2. nature ...

1. role financial intermediaries 2. nature and role of money markets

Define how forecast the exchange rate, As of November 1, 1999, the exchange...

As of November 1, 1999, the exchange rate in between the Brazilian real and U.S. dollar is R$1.95/$. The agreement forecast for the U.S. and Brazil inflation rates for the next 1-y

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