Cash flow yield analysis, Financial Management

Assignment Help:

A cash-flow yield is the discount rate that makes the price of a mortgage-backed or asset-backed security equal to the present value of its cash flows. It is equivalent to the yield to maturity measure. In mortgage-backed and asset-backed securities, because of prepayments, the cash flow is unknown; so some assumption about the prepayment rate must be made to calculate the cash-flow yield.

Different from a normal bond, which typically pays a coupon semi-annually, a mortgage-backed or asset-backed security makes monthly payments. Therefore, the investor has the opportunity to generate greater reinvestment income by reinvesting the monthly cash flows. In a treasury coupon security, bond-equivalent yield can be found out by doubling the semi-annual yield, but because of more frequent payments the same concept cannot be used in calculating the
bond-equivalent yield for mortgage-backed and asset-backed securities. The market convention is to calculate a yield so as to make it comparable to the yield to maturity on a bond-equivalent basis. The formula for annualizing the monthly cash flow yield for a monthly pay product is as follows:

         Bond-equivalent yield = 2 [(1 + iM)6 - 1]

Where, iM is the monthly interest rate that will equate the present value of the projected monthly cash flow equal to the market price (plus accrued interest) of the security.

Example: If the monthly cash flow yield is 0.8%, then the bond equivalent yield is  

2 x [(1.008)6 - 1] = 0.0979 = 9.79%.


Related Discussions:- Cash flow yield analysis

Determine the examples of icq and iceq, Examples of ICQ's and ICEQ's I...

Examples of ICQ's and ICEQ's ICQ: "Does an authorised senior person review purchase invoices before payment is made?" ICEQ: "Can payments be made on purchase invoices th

Special considerations for high-yield corporate bonds, High-yield ...

High-yield bonds are issued by organizations that do not qualify for "investment-grade" ratings by any one of the leading credit rating agencies

Significance of secondary markets, Significance of Secondary Markets: H...

Significance of Secondary Markets: High liquidity and constant demand in the market need a diversified investor base with different preferences of demand, maturity and risk. Ap

Cash discount, I am trying to solve this formula: 2/10, net 30. In the bo...

I am trying to solve this formula: 2/10, net 30. In the book I am reading they have 2% x 360 ------- ------ = 2.04% x 18=36.72% 100-2% (30-10) I want to know how the

Exchange Rate Parity Conditions, 1) According to the IFE (RIP), if U.S. inv...

1) According to the IFE (RIP), if U.S. investors expect a 3% rate of domestic inflation over one year, and a 6% rate of inflation in European countries that use the EUR, and requir

Explain the benefits of delegation from point of view of yt, YT is the Fina...

YT is the Finance Manager of SBM Magazine Publishing Company. He has recently had his appraisal and was expecting that he would get a excellent review, as he felt that he had met a

Compare diversifiable and nondiversifiable risk, Compare diversifiable and ...

Compare diversifiable and nondiversifiable risk. Which do you think is more important to financial managers in business firms? Diversifiable risk is able to be dealt with by of

What is a treasury bill? how risky is it?, What is a Treasury bill? How ris...

What is a Treasury bill? How risky is it? Treasury bills are the short-term debt instruments issued by the U.S. Treasury that are sell at a discounted and pay face value at mat

Cash budget, We need to have done some exploration work on all of the major...

We need to have done some exploration work on all of the major projects for inclusion in our prospectus, but of our $4m we need at least $1m in the bank to pay for all the listing

Definition of capital budgeting, Q. Definition of Capital Budgeting? Ca...

Q. Definition of Capital Budgeting? Capital Budgeting is the procedure of making decisions for investment in long-term assets. It is a method of deciding whether or not to inve

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd