CHAPTER 6
Analysis
Get the habit of analysis—analysis will in time enable synthesis to become your habit of mind.
—Frank Lloyd Wright
6.1 RISK FACTORS
In this section the risks affecting returns on a securitized structure are reviewed. The primary example is mortgage securitization, but many of these concepts apply to various types of asset-backed securities.
6.1.1 Prefunding
- For a prefunded deal, if the prefunded amount is not fully spent by the prefunding deadline, say three months after settlement, then the excess prefunding cash is effectively a prepayment that pays down the bonds. This will shorten the bonds and may lessen their yield. In general, if a bond is purchased at a premium and pays down faster than anticipated, then the yield will be lower than anticipated.
- When prefunding assets, the assets purchased may differ slightly from the characteristics stipulated in the the prospectus. This difference should be small and not impact the performance of the deal. A similar risk is inherent in an actively managed collateralized debt obligation (CDO).
6.1.2 Prepayments
- A prepayment option is the ability of a borrower to pay down his loan faster than the scheduled amortization. Various ABS loans have prepayment risk to different degrees: mortgages, student loans, auto loans, and the like. In general, prepayment risk is the relative devaluation of a prepayable bond compared to a nonprepayable bond. Consider a par bond. Interest rates ↓⇒ prepayments ↑⇒ excess cash needs to ...
