mortgage
pledge of property to secure payment of debt
Mortgage originator
The original lender
Mortgage Server
collects the monthly payments, forwards proceeds to the mortgage owners, sending payment notices, maintaining mortgage balances, furnishing tax info, administering an escrow account for taxes and insurance and initiation foreclosure proceedings
servicing fee
paid to the server to service the loan, typically between 25 - 100 baiss points per year
T or F: The mortgage originator can sell the servicing to another company
true
What are the choices once the loan is made
1 - hold the mortgage
2 - sell the mortgage to an investor who wished to hold the mortgage in its portfolio or will place it into a pool of mortgages to be used as collateral for the issuance of the security
3 - Use the mortgage themselves as collateral f
Amortization
the amount of the payment that represents principal repayment.
What does it mean to be fully amortizing
that they ensure that the principal is paid back by the time that the last payment is paid..
Mortgages are like this
Note Rate/Mortgage Rate
The interest rate the borrower agrees to pay
Can be fixed (FRM)
Can be variable (ARM)
What is a variable mortgage rate
ARM - linked with an index or reference rate with an additional premium (which is a margin)
How are the mortgage rates determined
- Market determined (LIBOR)
OR
- Cost of Funds (COFI or the national cost of funds index)
What are rates dictated by
- Periodic rate caps (how high the rate can increase at a reset date)
-Lifetime rate caps and floors (how high the rate can be over the term of the loan)
What is a periodic rate cap
how high the rate can increase at a reset date
what is a lifetime rate cap and floor
how high the rate can be over the term of the loan
Benchmark Rate is aka
Base Interest Rate (non Treasury)
What is the Benchmark Rate
minimum interest rate that investors want,
The base interest rate is often the YTM of the most recently issued comparable treasury security
(Absolute) Yield Spread
the difference between the yields of 2 bonds
Yield Spread = yield on bond A - yield on bond B
Quoted in Basis Points
Benchmark Spread
When Bond A is a NON-benchmark bond and Bond B is a Benchmark Bond, the benchmark spread is the yield spread, (which can also be considered a risk premium).
Benchmark spread = yield on bond A - yield on bond B
Relative Yield Spread
ratio of the yield spread to the yield level
Relative Yield Spread = (Bond A - Bond B) / Bond B
Yield Ratio
Yield Ratio = Yield on A / Yield on B
Credit spread
spread between treasury securities and non treasury securities that are identical in all respects except for this quality
What are factors that affect the spread
Types of Issuers
perceived creditworthiness of the issue
Term to maturity of the issue
provisions granted to either party
the liquidity
the taxability
the expected liquidity
Type of issuers
Which market sector they are in
US Gov
US Gov agencies
Munies
Credit (corporate)
Foreign Govs
Different types of credit secotrs
industrial
utility
finance
noncorporate
Intermarket sector spread
the spread between 2 interest rates in 2 sectors of the bond market (one treasury and one non treasury)
Intramarket sector bond
The spread of 2 different bonds in the same sector
What is the perceived creditworthiness of the issue
refers to the default risk
& credit spread,
the higher the credit rating, the smaller the credit spread
Term to maturity of the issue
the longer the bond life, the more uncertainity the more compensation
Provisions granted to either party
Call, puts, affects compensation
The liquidity affecting the spread
on the run issues are more liquid than off the run
The taxability affecting the spread
Munis do not have a federal tax obligation
To qualify, the yield must be less than the Treasuries at the same YTM
After Tax Yield
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Equivalent taxable yield
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Liquidity effects on the yield
the greater the liquidity, the lower the required yield
Because t-bills are most liquid, they have the lowest yield curve
The treasury yield curve
the graph depiction of the relationship between the yield on bonds of the same credit quality but of different maturities
Spot rate
the yield of a theoretical zero- coupon security with the same maturity
How to find the spot rates
1) graph the cfs
2) find the PV of the cfs by solving for the rate that needs to be spotted
3) divide by 3
What is the Present Value formula
P = [(C1) / (1 + r1)^1] + [(C2) / ( 1 + r2)^2] .... + [(Cn + M) / (1 + rn) ^n]
Spot Rate Curve
the graphical depiction of the relationship between the spot rate and the maturity
Theoretical spot rate curve
depicts the graphical term structure of interest rate, but since it is impossible to construct a spot rate curve solely from observations of market activitiy on Treasury securities because there is no zero-coupon treasury debt issues with a maturity great
What candidates are included in the theoretical spot rate curve?
On the Run treasury issues
selected off the run treasury issues
all treasury coupon securities and bills
treasury coupon strips
The forward rate
the rate at which you can invest at a certain point in time
Liquidity of CDOs
There is a secondary market for mortgage loans, but the bid-ask spreads are large compared to other debt instruments
Mortgage loans are rather illiquid because they are large and indivisible
The degree of liquidity determines the liquidity risk
CDOs
Collateralized Debt Obligations
financial tools that banks use to repackage individual loans into a product that can be sold to investors on the secondary market.
Packages made up of auto loans, CC loans, mortgages, or corporate debt
Why are CDOS considered collateralized
because of the promised repayment of the loans are the collateral that gives the CDOs value