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

Call risk, We have seen earlier that there are callable bonds. This i...

We have seen earlier that there are callable bonds. This is a valuable feature for the issuers who consider that their stock is undervalued enough so that selling

Explain the term phishing, QUESTION (a) (i) Describe briefly two potent...

QUESTION (a) (i) Describe briefly two potential E-Banking risks that may have an adverse impact on banks. (ii) Outline some measures to control these two risks. (b) Outli

Explain the meaning of ledger, Question 1 Write short notes on following- ...

Question 1 Write short notes on following- Explain any five important functions of accounting What is Book-Keeping? Explain features of book-keeping Question 2 Ex

Calculate expected gain or loss from the forward hedging, 1. A company sold...

1. A company sold a super computer to an Institute in Germany on credit and invoiced DM 10 million payable in six months. Presently, the six-month forward exchange rate is $1.50/DM

Bond market innovations, As liberalization is gathering momentum, cor...

As liberalization is gathering momentum, corporate treasures and merchant bankers are in the process of devising new products to suit the needs of investors and c

Determine the key factor affecting financing costs, Determine The key facto...

Determine The key factor affecting financing Costs Because cost of capital is measured under the assumption that both firm's asset structure and its capital (financial) structu

Obtain a market arbitrage position, (a) One could obtain a market arbitrag...

(a) One could obtain a market arbitrage position as follows: buy Honeywell shares as well as sell General Electric shares. If the merger gets place the Honeywell shares will conve

Return on investment , Return on Investment (ROI) In accounting it is a...

Return on Investment (ROI) In accounting it is a measure of the earning power of an industries asset. A high return on investments is desirable. ROI is widely described as net

Brigham, how do legal consideration affect a firms credit policy

how do legal consideration affect a firms credit policy

The selling process, The Selling Process The four key elements that con...

The Selling Process The four key elements that constitute the selling process are: (i) identification of prospective buyers, (ii) selection of the type of selling process to be

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