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Investment Glossary

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Investment Glossary Investment Glossary Investment Glossary — A — Bond-Equivalent Effective Margin (BEEM): The average spread of an adjustable rate security over the underlying index for the life of the instrument. Accrual Bonds: See Z Bonds. BEEM assumes the index remains constant and the coupon of the security completely resets to the Accrued Interest: Coupon interest earned but not index over time, taking into account all caps, collars yet paid from the time of the last coupon payment. and floors. ARM (Adjustable-Rate Mortgage): A mortgage Bond-Equivalent Yield (BEY): The yield of a loan whose coupon rate is adjusted periodically at mortgage security (a monthly yield) expressed on a a given margin over a specified index, such as the semi-annual equivalent basis. one-year Constant-Maturity Treasury or the 11th District Cost-of-Funds Index, subject to specified Buy-Down Loan: A loan whose monthly mortgage coupon change and lifetime caps. prepayments are subsidized by another party in the first several years after issuance. Home builders Allocation: The process by which the operations sometimes provide buy-down loans to assist home department of a brokerage firm matches mortgage purchasers in financing their properties. pools to orders for generic pools according to PSA’s good delivery guidelines, and subsequently notifies purchasers and sellers which mortgage pools will be — C — delivered on the settlement date. CAGE (Current Age): Current age (in months) of the underlying collateral. Amortization: A loan-repayment method whereby the total principal amount borrowed is repaid gradually during the life of the loan. The Cap: A maximum limit on the interest rate of a payment made by a mortgage holder each month is floating rate security. The coupon can not reset composed of interest on the outstanding principal above the Cap throughout the life of the security. amount and principal. Since the payment that is made by the mortgage holder is typically fixed, Cash-Flow Yield: The internal rate of return the interest component of the payment gradually of a mortgage security that equates all monthly decreases as the original principal balance is interest and principal cash flows (assuming a certain reduced. prepayment rate) to a given price plus accrued interest. Ask Price: The price at which a dealer is willing to sell a security. Cash Program (FHLMC): Through FHLMC’s Cash Program, loan originators sell their mortgage Average Life: The weighted-average time (in loans directly to FHLMC for cash. In turn, FHLMC years) the principal of a mortgage security is pools the mortgage loans of many originators into outstanding. An increase in prepayments of the mortgage Participation Certificates. underlying mortgage loans shortens the average life of a mortgage security since more principal has CMT (Constant Maturity Treasury): The Average been repaid and a smaller amount of principal will yield of Treasury Notes at constant maturities. be paid in the future. COFI (Cost of Funds Index): The average rate — B — paid on liabilities for SAIF institutions within a specified region. Common examples include the 11th District COFI (comprised of institutions within Balloon-Payment Mortgages: An amortizing the Federal Reserves 11th District) and the National mortgage loan, that requires that the entire COFI (comprised of all SAIF insured institutions in outstanding principal balance of the loan be repaid the country). on a certain date. Collar: The maximum amount the coupon of an Basis Point (bp): One-hundredth of one percent. adjustable rate security is allowed to change at each Normally used to describe the change in yield of a reset date. Also known as periodic cap. security (e.g., a yield increase from 7.13% to 7.14% would be a two basis point increase). Collateralized Bond Obligation (CBO): A multi-tranche, pay-through debt security employing Bid Price: The price at which a dealer is willing to a pool of high yield corporate bonds as collateral. purchase a security. The corporate bond portfolio is highly diversified by both issuer and industry. Principal and interest THE BAKER GROUP | 800.937.2257 PAGE 2 Investment Glossary payments on the underlying corporate bonds are Cost of Carry: The implied borrowing cost of the used solely to meet CBO principal and interest seller of a dollar roll or repurchase agreement. It obligations. The CBO is divided into several debt includes the value of the mortgage pass-through tranches and an equity portion. Similar to other security’s cash flow that was forfeited when the asset-backed securities, the CBO structure is security was lent to the buying party over the roll flexible and the debt may be structured in a variety period, as well as the difference between the sale of ways to satisfy investor cash flow requirements. A price and the buy price of the security. typical structure includes an A-rated senior secured tranche, a BB-rated second secured tranche and a Coverage Ratio (Revenue Credit): A coverage Z-tranche. The secured tranches are normally sold ratio measures an issuer’s ability to meet the debt to investors while the Z-bonds and equity portion service payments relative to the pledged revenue are retained by the CBO sponsor. Currently, due to stream. A high coverage ratio indicates a better restrictions imposed by the Investment Company ability to meet the expense in question. *General Act of 1940, CBOs are traded as private placements. benchmark for debt coverage ratio is >1.15x. Collateralized Mortgage Obligation (CMO): Current Face: The outstanding principal balance A sequential-pay security that is collateralized by of a security. mortgage pass-through securities or mortgage whole loans. — D — Companion Bonds: Bonds created to absorb Debt Service (Revenue Credit): The issuer’s the volatility removed from the PACs and TACs. debt service reflects the cash required over a fiscal Companion bonds receive any principal payments year for the repayment of interest and principal on a in excess of those scheduled for the call-protected debt issue. bonds. Likewise, principal payments to companion bonds can be delayed when prepayments slow Default: Failure of a home owner to meet and scheduled payments to extension-protected mortgage loan payments for a period of two bonds are met first. As a result, the average lives of or more months. A loan default may result in a these bonds have more variability than comparable foreclosure of the property. For GNMA and FNMA sequential pay bonds from traditional CMO securities, servicers advance principal and interest structures. Companions may also be referred to as payments during the time that any underlying “support” bonds. loans are in default. Following the foreclosure of any property, the outstanding principal balance CPR (Constant Prepayment Rate): A method of the loan is passed through to the GNMA and of measuring prepayments that assumes a constant FNMA pass-through investor as a prepayment portion of the outstanding MBS principal will of principal. FHLMC servicers advance only the prepay. 6% CPR assumes 6% of the outstanding interest payments for the underlying loans that are principal balance will prepay in one year. in default in a mortgage pool and guarantee the repayment of principal within one year of the date Construction Loan: A loan that finances of default. the construction or substantial rehabilitation of residential or commercial property. See Delay: Investors receive interest and principal from GNMA Construction-Loan Certificate/Project- mortgage pass-through securities after a stated LoanCertificate (CLC/PLC) Program. delay. The delay is stated to be 45, 50, 55 and 75 days for GNMAs, GNMA IIs, FNMAs and FHLMCs, Conventional Loan: A mortgage loan that is not respectively. For example, interest for the month of FHA-guaranteed or VA-insured. January would be paid on February 15 for GNMAs, February 20 for GNMA IIs, February 25 for FNMAs Convexity: The rate at which the duration of a and March 15 for FHLMCs. On these dates, the security changes as interest rates change. Positive security holder would also receive any principal convexity implies that for small, equal and opposite payments made by the mortgage holders during changes in interest rates, the increase in price if the month of January. However, since interest for rates go down will be more than the decrease in the month of January would be paid on February 1 if price if rates increase. Negative convexity, on the there were no delays, the actual delays are 14, 19, 24 other hand, implies that the increase in price if rates and 44 days, respectively. go down will be smaller than the decrease in price if rates increase. Dollar Roll: A short-term financing transaction for mortgage pass-through securities. Unlike repos Corporate Bond-Equivalent Yield: See Bond- and reverse repos, dollar rolls involve the sale/ Equivalent Yield. purchase and subsequent repurchase/resale of THE BAKER GROUP | 800.937.2257 PAGE 3 Investment Glossary substantially similar mortgage securities. A seller by Congress to buy predominantly conventional of a roll agrees to sell a mortgage security for an mortgage loans and securitize them into FHLMC agreed-upon-price on a given date and buy back a Participation Certificates (PCs). FHLMC is not an similar security at a future date, while a buyer of a agency of the U.S. Government, but it does have roll agrees to buy a mortgage security for a certain access to borrowing rights within the Federal price and then sell a similar security at a future date. Reserve System. FHLMC’s common stock is The seller of the roll receives the use of funds for held by the 12 Federal Home Loan Banks and its the time period, but forfeits the monthly cash flows preferred stock is held by the public. In the event from that security during the roll period.
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