Asset-backed securities

As noted, the coupon rate is the interest rate the issuer agrees to pay each year. The coupon rate is used to determine the annual coupon payment which can be delivered to the bondholder once per year or in two or more equal installments. As noted, for bonds issued in European bond markets and the Eurobond markets, coupon payments are made annually. Conversely, in the United Kingdom, United States, and Japan, the usual practice is for the issuer to pay the coupon in two semiannual installments. An important exception is structured products (e.g., asset-backed securities) which often deliver cash flows more frequently (e.g., quarterly, monthly). 

Some bonds include a provision in their offer particulars that gives either the bondholder and/or the issuer an option to enforce early redemption of the bond. The most common type of option embedded in a bond is a call feature. A call provision grants the issuer the right to redeem all or part of the debt before the specified maturity date. An issuing company may wish to include such a feature as it allows it to replace an old bond issue with a lower coupon rate issue if interest rates in the market have declined. As a call feature allows the issuer to change the maturity date of a bond it is considered harmful to the bondholder s interests therefore the market price of the bond at any time will reflect this. A call option is included in all asset-backed securities based on mortgages, for obvious reasons. 

Callable bonds, putable bonds, mortgage-backed securities, and asset-backed securities are examples of (1). Floating-rate securities and inflation-indexed bonds are examples of (2). Convertible bonds and exchangeable bonds are examples of (3). 

The source of dollar return called reinvestment income represents the interest earned from reinvesting the bond s interim cash flows (interest and/or principal payments) until the bond is removed from the investor s portfolio. With the exception of zero-coupon bonds, fixed income securities deliver coupon payments that can be reinvested. Moreover, amortizing securities (e.g., mortgage-backed and asset-backed securities) make periodic principal repayments which can also be invested. 

Mortgage-backed and asset-backed securities are backed by a pool of loans or receivables. For example, mortgage-backed securities are backed... 

Although it is commonly quoted by market participants, the cash flow yield suffers from limitations similar to the yield to maturity. These shortcomings include (1) the projected cash flows assume that the prepayment speed will be realized (2) the projected cash flows are assumed to be reinvested at the cash flow yield and (3) the mortgage-backed or asset-backed security is assumed to be held until the final payoff of all the loans in the pool based on some prepayment assumption. If the cash flows are reinvested at rate lower than the cash flow yield (i.e., reinvestment risk) or if actual prepayments differ from those projected, then the cash flow yield will not be realized. Mortgage-backed and asset-backed securities are particularly sensitive to reinvestment risk since payments are usually monthly and include principal repayments as well as interest. 

While covered bonds are often regarded as similar to asset-backed securities (ABS) and mortgage-backed securities (MBS), many noteworthy differences exist between them ... 

As already discussed, collateralised debt obligations are a form of security whose interest and principal payments are linked to the performance of a specific pool of assets (sourced either directly or by reference). These underlying assets act as the collateral for the issued notes, hence the name. In terms of basic principals, there are many similarities between CDOs and their predecessors asset-backed securities (ABS) (see Exhibit 15.5). The major difference between CDOs and other ABS securities is... 

As stated, balance sheet CDOs are almost exclusively cash-flow-based, and on that basis, cash flow CDOs are similar in nature to other asset-backed securitisations involving a special purpose vehicle (SPV). Like asset backed securities, assets are pooled together in order to collateralize the liabilities of the SPV. As the underlying assets are sold to the SPV,... 

Euro Zing I is a cash flow CDO that presents several features of novelty and interest. It is the first true arbitrage CDO of European asset-backed securities in that, 100% of the assets were sourced from the marketplace rather than an existing balance sheet. It is also the first CDO to use a unique, innovative dnal-currency liability structure in sterling and euro to access the sterling ABS market in a cost-efficient way as opposed to cnrrency swapping each asset individnally to a common cnrrency. 

This discussion covers the main factors affecting bond returns in the European fixed income market, namely, the random fluctuations of interest rates and bond yield spreads, the risk of an obligor defaulting on its debt, or issuer-specific risk, and currency risk. There are also other, more subtle sources of risk. Some bonds such as mortgage-backed and asset-backed securities are exposed to prepayment risk, but such instruments still represent a small fraction of the total outstanding European debt. Bonds with embedded options are exposed to volatility risk. However, it is not apparent that this risk is significant outside derivatives markets. 

Among the most popular structured products currently being offered in the market are asset-backed securities (ABSs) and collateralised debt obligations (CDOs). 

Asset 50 million face value of an A-rated asset-backed security Price 99.50... 

In addition to the more traditional cash flows from mortgages and loan assets, investment banks underwrite bonds secured with flows received by leisure and recreational facilities, such as health clubs, and other entities, such as nursing homes. Bonds securitizing mortgages are usually treated as a separate class, termed mortgage-backed securities, or MBSs. Those with other underlying assets are known as asset-backed securities, or ABSs. The type of asset class backing a securitized bond issue determines the method used to analyze and value it. 

Bear Stearns. Asset-Backed Securities Special Report, 5 December. 

Bhattacharya, A., and F. Fabozzi, eds. 1996. Asset-Backed Securities. New Hope, PA FJF Associates. 

The market in structured finance securities was hit hard in the wake of the 2007—2009 financial crisis. Investors shunned asset-backed securities in a mass flight to quality. As the global economy recovered from recession, interest in the securitization resumed. We examine the fallout in the market later in this chapter. First, we discuss the principle concepts in undertaking securitization. 

Investor interest in the ABS market has been considerable from the market s inception. This is because investors perceive asset-backed securities as possessing a number of benefits. Investors can ... 

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