The process of posting more collateral than is needed to obtain or secure financing. Overcollateralization is often used as a method of credit enhancement by lowering the creditor's exposure to default risk. |||Overcollateralization is often done in order to get a better debt rating from a credit rating agency. The principal underlying a pool of assets is often greater than the principal amount of the issued security by approximately 10-20%.For example, in the case of a mortgage backed security, the principal amount of an issue may be $100 million while the principal value of the mortgages underlying the issue may be equal to $120 million.
An acronym standing for "short-term interest rate" options or futures contract. Many companies and financial institutions use STIR contracts to hedge against borrowing or lending exposure.
An investment strategy that mimics the payoff of a call option. A synthetic call is created by purchasing the underlying asset, selling a bond and purchasing a put option. The strike price on the put option is equal to the face value of the bond, which serves as the exercise price of the synthetic call. A synthetic call produces the same overall payoff as a call option. The synthetic call will finish in the money when the price of the underlying asset is greater than the face value of the sold bond at the time of expiration. It will be out-of-the-money when the value of the bond is greater than that of the underlying asset. When the synthetic call is in the money, the profit is the difference between the price of the underlying asset and the face value of the bond. If the call finishes out of the money, the put option absorbs the loss from the underlying asset, with the exercise price of the put paying for the bond.
The discount from par value at the time that a bond or other debt instrument is issued. It is the difference between the stated redemption price at maturity and the issue price. |||An original issue discount bond is a bond issued at a price below par. The most extreme example of an OID is a zero-coupon bond. OID is considered to be a form of interest, so tax issues can get a bit complicated.
The option to enter into an interest rate swap. In exchange for an option premium, the buyer gains the right but not the obligation to enter into a specified swap agreement with the issuer on a specified future date. The agreement will specify whether the buyer of the swaption will be a fixed-rate receiver (like a call option on a bond) or a fixed-rate payer (like a put option on a bond).
The par value of a mortgage-backed security at the time it is issued. Unlike most other types of bonds, mortgage-backed securities return both principal and interest to the holder in periodic payments (usually monthly). Over time, the outstanding principal balance of a mortgage-backed security will be reduced. The original face remains an important and distinguishing piece of information associated with a mortgage-backed security. |||By definition, a new issue mortgage-backed security will have a pool factor of 1; in other words, the original face will equal the current face. As the principal is paid down, the current face will be less than the original face. The current face is derived by multiplying the original face by the current pool factor.
A specific type of hedging technique. STRIPEs combine interest rate swaps and interest rate caps in order to protect the borrower from changes in interest rates. Under this arrangement, the balance of a loan is split between a fixed rate and a floating rate with a cap. STRIPEs provide a partial hedge to interest rate changes in either direction. If rates increase, the lender will profit from the portion of the loan covered by the cap. If they fall, then the lender, who would take a fixed-rate receiver position, would also be protected against a loss.
The rate on a securitized asset pool - such as a mortgage-backed security (MBS) - that is "passed-through" to investors once management fees and guarantee fees have been paid to the securitizing corporation. The pass-through rate (also known as the coupon rate for the MBS) will be lower than the interest rate on the individual securities within the offering. |||For example, suppose that an agency takes two million dollars' worth of mortgage loans, each of which pays 6% interest, and turns them into a 5.5% mortgage-backed security. The 5.5% reflects the pass-through rate, and the agency takes the remaining 0.5% as a cut of the proceeds.The largest issuers of securitized assets are the Sallie Mae, Fannie Mae and Freddie Mac corporations. While these companies are for-profit business, their guarantees are backed by the U.S. government, giving them high credit ratings.
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