Measures of Return
Financial market assets generate two different streams of return: income through cash dividends or interest payments and capital growth through asset price appreciation. Headline stock market indices typically report on price appreciation only. They do not include the dividend income…
Spot Rates and Forward Rates
A forward rate is the interest rate on a loan beginning at some time in the future. A spot rate, on the other hand, is the interest rate on a loan beginning immediately. Therefore, the forward market rate is for…
Collateralized Debt Obligations (CDO)
Collateralized Debt Obligation (CDO) is a generic term used for a security backed by a diversified pool of one or more debt obligations. CDOs backed by corporate bonds and emerging market bonds are called Collateralized Bond Obligations (CBOs), whereas CDOs…
Non-mortgage Asset-backed Securities
Many non-mortgage assets could be used as collateral in securitization such as auto loans, credit card receivables, personal loans, and commercial loans. Asset-backed securities (ABS) that are not guaranteed by a government or quasi-government entity are subject to higher credit…
Commercial Mortgage-backed Securities
Commercial Mortgage-Backed Securities (CMBS) are backed by a pool of commercial mortgages on income-generating properties such as multi-family properties (e.g., apartments), office buildings, industrial properties, shopping centers, hotels, and healthcare facilities. Credit Risk In the U.S. and other countries where…
Prepayment Risk
A mortgage prepayment option works much like a call option for the borrower. Mortgage prepayments can take one of these two forms: the borrower increasing the amount/frequency of payments; or the borrower repaying/refinancing the entire outstanding balance. Prepayment risk is…
Residential Mortgage-backed Securities
The bonds created from the securitization of mortgages are called residential mortgage-backed securities (RMBS). In the US, securities backed by residential mortgages are divided into 3 groups: those guaranteed by a federal agency; those guaranteed by a GSE (government-sponsored enterprises such…
Residential Mortgage Loans
A mortgage loan is a loan secured by real estate in which the borrower is obliged to make a predetermined series of payments. The mortgage gives the lender the right to foreclose if the borrower defaults. Foreclosure allows the lender…
Structures of Securitizations
Internal credit enhancements are common for securitizations called subordination (or credit tranching). Note that a tranche is the French word for “slice,” so tranches are simply different slices of the same security. Tranches of Asset-Backed Securities Credit Tranching There could…
Measuring and Modifying Risks
A conversation on risk would be incomplete without a mention of the ability to measure the risk. Organizations need to evaluate the cost-benefit implications of modifying their risk profiles even as they remain within the governing body risk tolerance levels….
