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

Elements of financial management, Elements of Financial Management: Fin...

Elements of Financial Management: Financial management is the term given to the overall management of an organisation's finances. It includes a number of elements, or systems,

What is capital rationing, What is capital rationing? Should a firm practic...

What is capital rationing? Should a firm practice capital rationing? Why? Capital rationing is the practice of putting dollar limits on what will be invested in new capital bud

NPV, 2.5. Västerås Corporation plans to buy a truck for $40,000 and depreci...

2.5. Västerås Corporation plans to buy a truck for $40,000 and depreciate it fully over 5 years using straight-line method of depreciation. However, it plans to use it for 8 years

Rate changes and duration estimate, To calculate duration, we need to...

To calculate duration, we need to first obtain the values for V - and V + where V - is the price when the yield decreases by certain number of basis points and V +

calculate the value of the bond, a.) A bond of Rs. 1000 value carries a co...

a.) A bond of Rs. 1000 value carries a coupon rate of 10% and has a maturity period of 6 years. Interest is payable semi-annually. If the required rate of return is 12%, calculate

Capital asset pricing model, Can you draw Capital asset pricing model with ...

Can you draw Capital asset pricing model with example and explain?????

Yield curve risk, The graphical representation of the relationship between ...

The graphical representation of the relationship between yield and maturity is known as yield curve. Yield curve risk is the risk of experiencing an adverse

Amount of the total liabilities, A firm has net working capital of -$800. L...

A firm has net working capital of -$800. Long-term debt is $15,400, total assets are $24,800 and fixed assets are $19,100. What is the amount of the total liabilities.

Explain the concept of newsworthiness in the field of pr, Question 1: (...

Question 1: (a). A big multinational company wishes to employ a PR manager for all its PR activities. What according to you would be the advantages and disadvantages of having

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