Yield curve spread
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Yield curve spread on a simple mortgage-backed security is the flat spread over the treasury yield curve required in discounting a pre-determined coupon schedule to arrive at its present market price.
That is, the MBS yield curve spread is based on a comparison of the market price to a model of the bond which includes no variability in interest rate or mortgage repayment rates.
[edit] Definition
For mortgage-backed securities, a model of typical repayment rates tends to be given; the PSA formula for a particular Fannie Mae MBS might equate a particular group of mortgages to an 8 year amortizing bond with a 5% mortality per annum. This gives a single series of nominal cash flows (like a riskless bond). If these payments are discounted to net present value with a static treasury yield curve the sum of their values will tend to underestimate the market price of the MBS. The parallel shift, which, if applied to the yield curve makes the NPV of the anticipated receipts equal to the market price is the Yield curve spread.
[edit] Compare
Option adjusted spread For mortgage-backed securities, a model of typical repayment rates tends to be given; the PSA formula for a particular Fannie Mae MBS might equate a particular group of mortgages to an 8 year amortizing bond with a 5% mortality per annum. This gives a single series of nominal cash flows (like a riskless bond). If these payments are discounted to net present value with a static treasury yield curve the sum of their values will tend to OVERESTIMATE the market price of the MBS. The parallel shift, which, if applied to the yield curve makes the NPV of the anticipated receipts equal to the market price is the Yield curve spread.
[edit] References
Hayre, L. 2001, Salomon Smith Barney Guide to Mortgage-Backed and Asset-Backed Securities, Wiley ISBN 0-471-38587-5
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