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Evolution of Mortgage Instruments: Historical Perspective and Risk Management Strategies

This article explores the historical evolution of mortgage instruments, from traditional practices to modern financial tools. It delves into the challenges faced due to rate ceiling constraints, usury ceilings, and deregulation of liabilities and assets. Furthermore, it examines innovative mortgage designs aimed at mitigating interest rate risks, inflation/deflation uncertainties, and borrower payment burdens. The text also discusses various risk management strategies, such as hedging with financial tools, duration matching of assets and liabilities, and diversification of businesses to reduce risk exposure. Additionally, it analyzes the development of synthetic alternatives and defensive/offensive strategies in risk management.

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Evolution of Mortgage Instruments: Historical Perspective and Risk Management Strategies

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  1. THE STANDARD INSTRUMENT AND THE NATURE OF THE PROBLEM: AN HISTORICAL PERSPECTIVE • ASSET - LIABILITY MIX PROBLEM • RATE CEILING CONSTRAINTS • USURY CEILINGS • DE-REGULATION OF LIABILITIES AND ASSETS • ACTIVITY OF OTHER FINANCIAL INTERMEDIARIES AND WALL STREET

  2. ALTERNATIVE MORTGAGE INSTRUMENT DESIGN • INTEREST RATE RISK • INFLATION / DEFLATION

  3. INSTRUMENT MODIFICATION TO REDUCE RISKS OF INTEREST RATE UNCERTAINTY • PARTICIPATION IN EQUITY • SHORTENING OF MATURITIES

  4. VRMs vs GPMs • VRMs • VARIABLE PAYMENT / FIXED TERM • VARIABLE TERM / FIXED PAYMENT HYBRIDS • RESTRICTED VS. UNRESTRICTED • GPMs • TOTAL BALLOON • INTEREST ONLY • PARTIAL PRINCIPLE PAYDOWN • AMORTIZED LOAN • GEM

  5. DESIGN OBJECTIVES • TILT PROBLEM OF BORROWER • RATE RISK OF LENDER • LONG RUN “PAYMENT RISK” BURDEN TO BORROWER • SHORT RUN “PROPERTY VALUE RISK” TO LENDER

  6. PROBLEMS INHERENT IN DESIGN OF MORTGAGES • INDEX CHOICE AND REAL RETURNS • SECONDARY MARKETABILITY

  7. RISK MANAGEMENT STRATEGIES • HEDGING WITH FINANCIALS - FUTURES - OPTIONS • BETTER DURATION MATCHING OF ASSETS AND LIABILITIES • NO HOLD STRATEGIES - REMICs • DIVERSIFICATION OF BUSINESSES • RISK SHARING ALTERNATIVES THROUGH INSTRUMENT DESIGN

  8. RISK MANAGEMENT STRATEGIES SYNTHETIC ALTERNATIVES REDUCE RISK DEFENSIVE STRATEGY OFFENSIVE STRATEGY

  9. MODULE DEVELOPMENT • TOOLS OF RISK MANAGEMENT • PORTFOLIO BALANCE AND RISK-RETURN BALANCE • DESIGN OF ALTERNATIVE MORTGAGE INSTRUMENTS • HEDGING TECHNIQUES FOR “PIPELINE” ACTIVITIES • LIQUIFICATION OF PORTFOLIO • LIABILITY MANAGEMENT • DIVERSIFICATION OF ASSETS

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