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VI: Debt Market Instruments 20: Asset-Backed Securities
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Asset Backed Securities Investment Companies Investment Trusts Open End Companies (Mutual Funds) Closed End Companies Securitization Mortgage Backed Securities Other Securitization
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Chapter 20: Asset-Backed Securities Investment Companies © Oltheten & Waspi 2012
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Net Asset Value Net Asset Value = Market Value of Assets Units
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Open Ended (Mutual Fund) We can create a new partnership (unit) only if we have Open Ended Capitalization
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Open Ended (Mutual Fund) We can destroy the partnership (unit) only if we have Open Ended Capitalization. This can entail selling assets to realize sufficient funds to redeem the unit.
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Closed End Fund Cannot create new partnership units Closed End Capitalization means that the number of units are fixed)
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 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.
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Why Investment Companies Economies of scale Diversification Lower transaction costs Professional management
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Performance Average annual return 1980-2005 S&P Index12.3% 10.0% 7.3% Mutual Funds Mutual Fund Investor
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Performance Average annual return 1980-2010 © Oltheten & Waspi 2012 S&P Index8.06% 10.0% 7.3% Mutual Funds Mutual Fund Investor
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Chapter 20: Asset-Backed Securities Mortgage Backed Securities © Oltheten & Waspi 2012
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Mortgages Structured so that payments are Monthly Even over the life of the loan
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Mortgages $1,000,000 principal loan 8½% 30 years
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Mortgages $1,000,000 principal loan 8½% 30 years Monthly mortgage payment? How much is principal repayment How much is interest? After the first payment what is the loan principal?
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Mortgages Month One: Payment = $7,689.13 Interest = $7,083.33 Principal = $605.80 Now owe $999,394.20
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Chapter 20: Asset-Backed Securities 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] Clear 12 pmts/yr End of Period pmts Calculator Mode PV=-$1m Rate = 8.5% N=360 months $7,689.13
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Calculator Techniques [2nd]Amort [2nd][CLR WORK] [↓] 12 Amortization P1 = 1 P2= P2=1 BAL = - 999,394.20 PRN = 605.80 INT = 7,083.33 P1=1 to P2=1 means that you get month 1 only
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Chapter 20: Asset-Backed Securities Mortgages © Oltheten & Waspi 2012
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Chapter 20: Asset-Backed Securities Mortgages © Oltheten & Waspi 2012
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Primary Market The bank writes 10, 30 year mortgages of $1,000,000 at 8½% No more money
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Chapter 20: Asset-Backed Securities Primary Market -> Secondary Market © Oltheten & Waspi 2012 Mortgages Secondary Market Investors $$$ Bank $$$ More Mortgages
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 The Secondary Market If the Bank can sell the mortgages to investors then it will have capital to extend more loans.
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 The Secondary Market Put the 10 $1m mortgages into a $10,000,000 pool (group) Guarantee each mortgage by GNMA or FNMA
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 The Secondary Market GNMA Government National Mortgage Association Wholly owned government corporation within HUD Neither originates or purchases mortgage loans FNMA Federal National Mortgage Association GSEs owned by its shareholders (until Sept 7, 2008) In 2008 owned approx ½ of the $12 trillion mortgage market
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 The Secondary Market Divide the pool into 1000 $10,000 units 8.0% goes to the Investor 0.1% goes to Ginnie Mae 0.4% goes to the Originating Bank (me) I sell the units to investors through a broker
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Pass Through Securities 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.
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Risk 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.
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 CMO Put Through securities: all units in a pool are equal Collateralized Mortgage Securities: units are unequal. inventive structures Tranches / classes
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 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
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Chapter 20: Asset-Backed Securities © Oltheten & Waspi 2012 Securitization Mortgages Car Loans Consumer debt
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