Although CMOs entitle investors to payments of principal and interest,black uggs, they differ from corporate bonds and Treasury securities in significant ways. Corporate and Treasury bonds are issued with stated maturities. The purchase of a bond from an investor is essentially a loan to the issuer in the amount of the principal, or face amount, of the bond for a prescribed period of time in return for a specified annual rate of interest. The bondholder receives interest, generally in semiannual payments, until the bond is redeemed. When the bond matures,replica chanel watches, or is called by the issuer, the issuer returns face value of the bond to the investor in a single principal payment.
With a CMO, the ultimate borrower is the homeowner who takes who takes on a mortgage loan. Because the homeowner's monthly payments include both interest and principal, the mortgage security investor's principal is returned over the life of the security, or amortized rather than repaid in a single lump sum at maturity. CMOs provide monthly or quarterly payments to investors which include varying amounts of both principal and interest. As the principal is repaid (or prepaid), the interest payments become smaller because they are based on a lower amount of outstanding principal.
A mortgage security "matures" when the investor receives the final principal payment. Most CMO tranches have a stated maturity based on the last date on which the principal from the collateral could be paid in full. This date is theoretical, because it assumes no prepayments on the underlying mortgage loans.
Mortgage securities are more often discussed in terms of their average life rather than their stated maturity date. Technically, the average life is defined on the average time to receipt of each dollar of principal, weighted by the amount of each principal payment. In simpler terms, the average life is the average time that the principal dollar in the pool is expected to be outstanding,coach bags outlet, based on certain assumptions about prepayment speeds. If prepayment speeds are faster than expected, the average life of the CMO will be shorter than the original estimate; if prepayment speeds are slower, the CMOs average life will obviously be extended. While some CMO tranches are specifically designed to minimize the effects of variable prepayment rates, the average life of the security is always a best estimate, contingent on how closely the actual prepayment speeds of the underlying mortgage loans match the assumptions.
CALCULATING PREPAYMENT SPEEDS
Estimates based on historic prepayment rates for each particular type of mortgage loan under various economic conditions from various geographical areas, are factored into the offering price, yield, and market value of a CMO. The realization of the average life and yield estimates depends on the accuracy of the prepayment assumptions. Different standard and proprietary prepayment rates exist, but one of the most common ways of expressing prepayment rates is in terms of the Standard Prepayment Model of The Bond Market Association. Developed in 1985 for specific application to mortgage securities, the Association's model assumes that new mortgage loans are less likely to be prepaid than somewhat older, more seasoned mortgage loans. Projected and historical prepayment rates are often expressed as "percentage of PSA" (Prepayment Speed Assumptions).
INTEREST RATES AND YIELD ON CMOS
The interest rates paid on CMOs will be lower than the interest rates paid on the underlying mortgage loans, because the issuer retains a portion of the interest paid by the mortgage borrower as a servicing fee for creating the security and collecting and distributing the monthly payments to investors. Still, newly issued mortgage securities carry higher estimated yields than comparable Treasury securities. In part, this is because the interest rates paid by home buyers are higher than the interest rates paid by the U.S> government. However, the higher interest rates on mortgage securities also reflect compensation for the uncertainty of their average lives.
As with any bond, the yield on a CMO depends on the purchase "price" in relation to the interest rate and the length of time the investor's principal remains outstanding. CMO yields are often quoted in relation to yields on Treasury securities with maturities closest to the CMOs estimated average life. The estimated yield on a CMO reflects its estimated average life based on the assumed prepayment rates for the underlying mortgage loans. If actual prepayment rates are faster or slower than anticipated, the investor who holds the CMO until it is fully paid may realize a different yield. For securities purchased at a discount to face value, faster prepayment rates will increase the yield-to-maturity, while slower prepayment rates will reduce it. For securities purchased at a premium, faster prepayment rates will reduce the yield-to-maturity, while slower rates will increase it. For securities purchased at face value (par), these effects should be minimal.
Because CMOs pay monthly or quarterly, as opposed to the semi-annual interest payment schedule for most bonds, CMO investors can use their interest income much earlier than other bond investors. Therefore, CMOs are often discussed in terms of their bond equivalent yield, which is the actual CMO yield adjusted to account for its greater present value resulting from more frequent interest payments.
THE EFFECT OF INTEREST RATES ON CMO VALUES AND PREPAYMENT RATES
Prevailing market interest rates affect CMOs in two major ways. First, as with any bonds, when interest rates rise,kelly bags sale, the market price or value of most types of outstanding CMO tranches drops in proportion to the time remaining to the estimated maturity. Conversely, when rates fall, prices of outstanding CMOs generally rise, creating the opportunity for capital appreciation if the CMO is sold prior to the time when the principal is fully repaid.
Movements in market interest rates have a greater effect on CMOs than on other fixed-interest obligations because rate movements affect the underlying mortgage loan prepayment rates and, consequently, the CMO's average life and yield. When interest rates decline, homeowners are more likely to refinance their mortgages or purchase new homes to take advantage of the lower cost of financing. Prepayment speeds therefore accelerate in a declining interest rate environment. When rates rise, homeowners are more likely to "stay put", causing prepayment speeds to slow.
What is good for the homebuyer is not necessarily good for the CMO investor. If interest rates fall and prepayment speeds accelerate, CMO investors may find they get their principal back sooner than expected and have to reinvest it at lower interest rates ("call risk"). If interest rates rise and prepayment speeds are slower, investors may find their principal committed for a longer period of time, causing them to miss the opportunity to earn a higher rate of interest (extension risk). Therefore, investors should carefully consider the effect that sharp moves in interest rates would have on the performance of their CMO investment.
For the above reasons described, CMOs are considered by a select few platforms to be an asset that is easy to validate and prove ownership. In addition, the trading platform is able to be added as the CMOs Beneficiary allowing for the appropriate financing lines to be obtained. The result is a CMO asset that can be purchased for pennies on the dollar with nominal returns and subsequently placed and traded successfully in a Private Trading Program with yields the owner once only dreamed of.
With a CMO, the ultimate borrower is the homeowner who takes who takes on a mortgage loan. Because the homeowner's monthly payments include both interest and principal, the mortgage security investor's principal is returned over the life of the security, or amortized rather than repaid in a single lump sum at maturity. CMOs provide monthly or quarterly payments to investors which include varying amounts of both principal and interest. As the principal is repaid (or prepaid), the interest payments become smaller because they are based on a lower amount of outstanding principal.
A mortgage security "matures" when the investor receives the final principal payment. Most CMO tranches have a stated maturity based on the last date on which the principal from the collateral could be paid in full. This date is theoretical, because it assumes no prepayments on the underlying mortgage loans.
Mortgage securities are more often discussed in terms of their average life rather than their stated maturity date. Technically, the average life is defined on the average time to receipt of each dollar of principal, weighted by the amount of each principal payment. In simpler terms, the average life is the average time that the principal dollar in the pool is expected to be outstanding,coach bags outlet, based on certain assumptions about prepayment speeds. If prepayment speeds are faster than expected, the average life of the CMO will be shorter than the original estimate; if prepayment speeds are slower, the CMOs average life will obviously be extended. While some CMO tranches are specifically designed to minimize the effects of variable prepayment rates, the average life of the security is always a best estimate, contingent on how closely the actual prepayment speeds of the underlying mortgage loans match the assumptions.
CALCULATING PREPAYMENT SPEEDS
Estimates based on historic prepayment rates for each particular type of mortgage loan under various economic conditions from various geographical areas, are factored into the offering price, yield, and market value of a CMO. The realization of the average life and yield estimates depends on the accuracy of the prepayment assumptions. Different standard and proprietary prepayment rates exist, but one of the most common ways of expressing prepayment rates is in terms of the Standard Prepayment Model of The Bond Market Association. Developed in 1985 for specific application to mortgage securities, the Association's model assumes that new mortgage loans are less likely to be prepaid than somewhat older, more seasoned mortgage loans. Projected and historical prepayment rates are often expressed as "percentage of PSA" (Prepayment Speed Assumptions).
INTEREST RATES AND YIELD ON CMOS
The interest rates paid on CMOs will be lower than the interest rates paid on the underlying mortgage loans, because the issuer retains a portion of the interest paid by the mortgage borrower as a servicing fee for creating the security and collecting and distributing the monthly payments to investors. Still, newly issued mortgage securities carry higher estimated yields than comparable Treasury securities. In part, this is because the interest rates paid by home buyers are higher than the interest rates paid by the U.S> government. However, the higher interest rates on mortgage securities also reflect compensation for the uncertainty of their average lives.
As with any bond, the yield on a CMO depends on the purchase "price" in relation to the interest rate and the length of time the investor's principal remains outstanding. CMO yields are often quoted in relation to yields on Treasury securities with maturities closest to the CMOs estimated average life. The estimated yield on a CMO reflects its estimated average life based on the assumed prepayment rates for the underlying mortgage loans. If actual prepayment rates are faster or slower than anticipated, the investor who holds the CMO until it is fully paid may realize a different yield. For securities purchased at a discount to face value, faster prepayment rates will increase the yield-to-maturity, while slower prepayment rates will reduce it. For securities purchased at a premium, faster prepayment rates will reduce the yield-to-maturity, while slower rates will increase it. For securities purchased at face value (par), these effects should be minimal.
Because CMOs pay monthly or quarterly, as opposed to the semi-annual interest payment schedule for most bonds, CMO investors can use their interest income much earlier than other bond investors. Therefore, CMOs are often discussed in terms of their bond equivalent yield, which is the actual CMO yield adjusted to account for its greater present value resulting from more frequent interest payments.
THE EFFECT OF INTEREST RATES ON CMO VALUES AND PREPAYMENT RATES
Prevailing market interest rates affect CMOs in two major ways. First, as with any bonds, when interest rates rise,kelly bags sale, the market price or value of most types of outstanding CMO tranches drops in proportion to the time remaining to the estimated maturity. Conversely, when rates fall, prices of outstanding CMOs generally rise, creating the opportunity for capital appreciation if the CMO is sold prior to the time when the principal is fully repaid.
Movements in market interest rates have a greater effect on CMOs than on other fixed-interest obligations because rate movements affect the underlying mortgage loan prepayment rates and, consequently, the CMO's average life and yield. When interest rates decline, homeowners are more likely to refinance their mortgages or purchase new homes to take advantage of the lower cost of financing. Prepayment speeds therefore accelerate in a declining interest rate environment. When rates rise, homeowners are more likely to "stay put", causing prepayment speeds to slow.
What is good for the homebuyer is not necessarily good for the CMO investor. If interest rates fall and prepayment speeds accelerate, CMO investors may find they get their principal back sooner than expected and have to reinvest it at lower interest rates ("call risk"). If interest rates rise and prepayment speeds are slower, investors may find their principal committed for a longer period of time, causing them to miss the opportunity to earn a higher rate of interest (extension risk). Therefore, investors should carefully consider the effect that sharp moves in interest rates would have on the performance of their CMO investment.
For the above reasons described, CMOs are considered by a select few platforms to be an asset that is easy to validate and prove ownership. In addition, the trading platform is able to be added as the CMOs Beneficiary allowing for the appropriate financing lines to be obtained. The result is a CMO asset that can be purchased for pennies on the dollar with nominal returns and subsequently placed and traded successfully in a Private Trading Program with yields the owner once only dreamed of.
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