Final Review - AssetBacked Securities Created by pooling...

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Asset-Backed Securities: - Created by pooling loans and/or receivables - Collateral can be classified as: o Nonamortizing assets Loans in which the borrower must make a minimum periodic payment (i.e. credit card receivables) o Amortizing assets Loans in which the borrower’s periodic pymt consists of scheduled principal and int pymts over the life of the loan Any excess pymt over the scheduled principal pymt is called prepymt (i.e. car loans) Must project prepayments - For all ABS, projection of CF’s requires modeling defaults - CDO: A security backed by a diversified pool of one or more of the following o Emerging market bonds o Foreign bank loans o ABS o US domestic bank loans Bonds with Embedded Options: - Price/yield relationship for an option-free bond is convex; For a callable bond price/yield relationship is not always convex - Positive Convexity: Option-free bond; price appreciation will be greater than the price depreciation for a large change in yield - Negative Convexity: Price appreciation will be less than the price depreciation for a large change in yield - Pricing a Bond with Embedded Options:: useful to decompose bonds into component parts o Callable bond price = noncallable bond price – call option price o
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