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cff cfa l2 ss15 Fixed Income Pt 2
Terms in this set (30)
"To Be Announced" aka TBA trade
Mortgage pool in an MBS where actual pool in underlying agency passthrough are not specified. Parties do agree on agency type, agency program, coupon rate, face value, price, and settlement date.
% of original mortgage pool balance that is outstanding.
"Generic" passthrough MBS
Often quoted by dealers describing general characteristics and not a specific pool. Projected prepayment rates reported by dealers are for generic passthroughs.
Can separate contraction and extension risk with traunches. Each traunche can have a different average life which would attract who have a preference different than the avg life of the collateral.
Interest Only (IO) traunche in a CMO where coupon rate is below collateral's coupon rate so that excess interest can be generated. The excess interest creates the S-IO
ABS vs. MBS
ABS have prepayment risk AND credit risk. MBS only prepayment.
"Weak Link" philosophy
Credit quality of an ABS issue cannot be higher than the credit rating of the third-party guarantor. If guarantor downgraded, issue MAY be downgraded too.
1. Cash reserve - cash deposits from issuance proceeds.
2. Excess servicing spread funds - spread over the servicing fee that generate excess cash.
When ABS is issued with a face amount that is LOWER than the value of the underlying capital. Difference is used to offset losses.
Shifting interest mechanism
Mechanism for addressing change in level of credit protection provided by junior traunches as prepayments occur in senior/subordinated structure. Reduces credit risk in senior, but trade-off greater prepayment risk.
Shifting interest reasoning
Basically designed to maintain a desired level of subordinate interest (junior traunche), prepayments are allocated by a certain % to senior traunches. Otherwise, juniors get paid off too quick.
Available funds cap
A variable cap on interest rate adjustments in the HEL floaters.
Absolute Prepayment Speed (ABS)
Measure of prepayments associated with securities backed be auto loans. m = months since
SMM = _____ABS______ loan origination
1 - [ ABS x (m - 1)
Deferment period for Student Loans
Borrower makes no payments and loan accrues not interest.
Grace period for Student Loans
Borrower makes no payments, but interest does accrue.
Loan repayment period
Borrower makes principal and interest payments based on a reference rate plus a margin.
Note: Prepayments come from default or loan consolidation.
Credit Card Receivable-backed securities
Use a structure where receivables can be added, so balance may never get to 0. If prepayments occur during lockout period, money is used to buy more receivables.
Distribution of payments for credit card backed securities (can be 1 or 3)
1. Passthrough - principal received is distributed pro-rata to investors.
2. Controlled -amortization - uses "principal window" similar to a PAC
3. Bullet-payment - investors recieve total principal amount in a single payment.
Performance Measure for credit card ABS - Net Portfolio Yield
= Gross portfolio yield - charge offs.
Warning - if wghted avg coupon promised to ABS traunche is greater than Net Portfolio Yield, traunches may not get paid as promised.
Perfomance Measure for credit card ABS - Delinquencies
% of past due receivables
Warning - High delinquencies signal potential future charge offs and lower net portfolio yield.
Performance Measure for credit card ABS - Monthly repayment rate (MPR)
Monthly payments (principal, interest, fees) as % of outstanding receivables at prev. month end.
Warning - Low MPR signals extension risk in traunches and not enough cash to pay off traunches.
CDO Cash Flow: 3 Phases
1. Ramp Up - Portfolio created with sale of different traunches to investors.
2. Reinvestment - Monitor performance and reinvest prepayments from calls and loan default recoveries.
3. Pay Down - Principal payments made to junior and senior traunches.
CDO Payment Order
In reinvestment period, principal proceeds are reinvested in new securities. After, prinicipal payments pay down senior traunches FIRST, then mezzanine, then equity.
Clean up Call Provisions - % of Collateral call
Outstanding bonds can be called at par value if the outstanding COLLATERAL's balance falls below a predetermined % (usually 10%) of the original collateral's balance.
Clean up Call Provisions - % of Bond Call
Outstanding bonds can be called at par value if the outstanding BOND's par value relative to the original par value of bonds issued falls below a specified amount.
Bond Equivalent Yield
Monthly cash flow yield is converted to bond equivalent to compare with Yield to Maturity
= 2 [ (1+monthly cash flow yield)^6 - 1]
Limitations of using the Z spread
Only considers one path of interest rate: i.e. the current Treasury spot rate curve vs. OAS which is added to spot rates along each and every path of the interest rate tree.
= Z-spread - OAS
Remember MBS are path dependent due to prepayment burnout. Therefore, a binomial model cannot be used for valuation, you have to use Monte Carlo.
Monte Carlo model weaknesses
Monte Carlo models are very sensitive to interest rate volatility and prepayment assumptions.