Asset Backed Securities - PowerPoint PPT Presentation

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    1. Financial Markets and the instruments that Trade in them 2006 Asset Backed Securities

    2. Financial Markets and the instruments that Trade in them 2006

    3. Financial Markets and the instruments that Trade in them 2006 Investment Companies

    4. Financial Markets and the instruments that Trade in them 2006 Investment Companies Open Ended (Mutual) Funds Create and destroy/redeem units as needed Primary market only Closed End Funds Units are fixed After initial offering units must be bought and sold in the secondary market where they trade just like stocks.

    5. Financial Markets and the instruments that Trade in them 2006 Economies of scale Diversification Lower transaction costs Professional management Why Investment Companies

    6. Financial Markets and the instruments that Trade in them 2006 Mortgage Backed Securities

    7. Financial Markets and the instruments that Trade in them 2006 Mortgages Structured so that payments are Monthly Even over the life of the loan

    8. Financial Markets and the instruments that Trade in them 2006 Mortgages $1,000,000 principal loan 8% 30 years

    9. Financial Markets and the instruments that Trade in them 2006 Mortgages $1,000,000 principal loan 8% 30 years Monthly mortgage payment? How much is principal repayment How much is interest? After the first payment what is the loan principal?

    10. Financial Markets and the instruments that Trade in them 2006 Mortgages Month One: Payment = Interest = Principal = Now owe:

    11. Calculator Techniques [2nd][Quit] [2nd][FV] [2nd][P/Y] 12 [2nd][BGN] [2nd][Quit] 1000000 [PV] 8.5[I/Y] 30 [2nd][xP/Y][N] [CPT][PMT]

    12. Calculator Techniques [2nd]Amort [2nd][CLR WORK] [?] 12

    13. Financial Markets and the instruments that Trade in them 2006 Mortgages

    14. Financial Markets and the instruments that Trade in them 2006 Mortgages

    15. Financial Markets and the instruments that Trade in them 2006 Primary Market The bank writes 10, 30 year mortgages of $1,000,000 at 8% No more money

    16. Financial Markets and the instruments that Trade in them 2006 The Secondary Market If the Bank can sell the mortgages to investors then it will have capital to extend more loans.

    17. Financial Markets and the instruments that Trade in them 2006 The Secondary Market Put the 10 $1m mortgages into a $10,000,000 pool (group) Guarantee each mortgage by the Government National Mortgage Association (GNMA) Federal National Mortgage Association (FNMA)

    18. Financial Markets and the instruments that Trade in them 2006 The Secondary Market Divide the pool into 1000 $10,000 units 8.0% goes to the Investor 0.1% goes to GNMA (or FNMAe) 0.4% goes to the Originating Bank (me) I sell the units to investors through a broker

    19. Financial Markets and the instruments that Trade in them 2006 A pass-through security is a pro-rated ownership of all the mortgages in the pool Each unit represents 1/1000th of each of the 10 mortgages in the pool. Pass Through Securities

    20. Financial Markets and the instruments that Trade in them 2006 Credit Risk: There is no credit risk because if the homeowner defaults GNMA will use its own funds to make payments until the mortgage is foreclosed and the mortgage paid off. Prepayment or Contraction Risk: This is the risk that the mortgage is paid off early. Prepayment risk is similar to an open call without penalty. Risk

    21. Financial Markets and the instruments that Trade in them 2006 Put Through securities: all units in a pool are equal Collateralized Mortgage Securities: units are unequal. inventive structures Tranches / classes CMO

    22. Financial Markets and the instruments that Trade in them 2006 Securitization Securitization is the process by which loans are turned into securities for sale to investors. The creation of this secondary market allows the primary market to function more efficiently

    23. Financial Markets and the instruments that Trade in them 2006 Securitization Mortgages Car Loans Consumer debt