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

Export/import bank (eximbank), Export/Import Bank (Eximbank) Federal Im...

Export/Import Bank (Eximbank) Federal Import-Export Bank, whose mainly function originally was to compensate U.S. exporters for subsidies approved competitors by foreign govern

Marginal analysis, MARGINAL ANALYSIS It is difficult to develop the co...

MARGINAL ANALYSIS It is difficult to develop the conditional profit table when there are a large number of scenarios and possible actions. The marginal analysis approach sides

Analyse interest rate swap and currency swap, Problem: (a) Critically ...

Problem: (a) Critically analyse interest rate swap and currency swap. (b) Explain why a bank may face credit risk when it enters into offsetting swap contracts. (c) Two

Illustrate working capital cycle in a manufacturing business, Working capit...

Working capital cycle in a manufacturing business Average time raw materials are in stock (raw materials/purchases x 365 days)   Plus   Time

Stock market, functions of stock market in usa

functions of stock market in usa

How do tax considerations affect the cost of debt, How do tax consideration...

How do tax considerations affect the cost of debt and the cost of equity? For the reason that interest on debt is tax deductible to the issuing firm, the higher the tax rate th

Explain swap dealer, Explain Swap Dealer A swap dealer is a market make...

Explain Swap Dealer A swap dealer is a market maker of swaps and predicts a risk position in matching opposite sides of a swap and in making sure that every counterparty fulfil

Domestic factors were important than international factor, Why do you think...

Why do you think the empirical studies as regards factors influencing equity returns mainly showed that domestic factors were more significant than international factors, and, seco

Demand at each particular exchange rate, The usual number of passengers usi...

The usual number of passengers using the service is dependent upon the demand at each particular exchange rate. At 1·52 Euro/£ expected demand = (0·33·)(500 + 460 + 420) = 460

Regular versus special redemption prices, The call prices for vario...

The call prices for various issues mentioned above are known as regular redemption prices. Point to be noted is that the regular redemption prices are above

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