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Published: 7th February 2012 by William Webster
Should a long dated mortgage asset be priced off the long dated cost of money? Or should it be priced off a shorter rate reflecting the fact that firms finance by borrowing short term and rolling this over?
Albeit that the cost of refinancing can be “modelled” to imply an increased charge for future stressed market conditions. The answer must depend on the maturity of the mortgage.
This may substantially vary from its contractual maturity. Ignoring amortisation and pre-payments consider three types of mortgage - fixed rate, tracker and administered.
With the first two a firm cannot increase the spread it charges. With the administered it can.
If the original mortgage term was 25 years and this was financed by one year retail money what liquidity risk is being run?
In the case of fixed and tracker products it is large. The firm must pay whatever it takes to refinance and the customer has no incentive to pre-pay. But with an administered rate product there is a difference – the cost can be passed on. Furthermore a firm could use the administered rate to accelerate repayment by simply making it uneconomic for the customer to stay.
In this way you could argue that an administered mortgage has a much shorter duration and therefore could be priced off short term funding rates. How short those rates should be is open to conjecture. You could argue that a 1 year rate is sufficient and that this is consistent with a matched maturity approach to FTP.
With TCF it would be helpful to get a regulator’s view on this.
Displaying 1 to 6 of 6 results in total.
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Selling mortgages with interest rates of between 1% and 4% may seem like an opportunity too good to miss, particularly now Bank rate is 0.10%, but is this too good to be true? Let’s see.
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Borrowers (issuers) often use the bond market to access medium and longer dated funding. Some issuers prefer variable rate liabilities, some fixed rate liabilities. All issuers want to be able to borrow the required amount at the lowest possible cost but just how does a fixed coupon bond issuer calculate the cost of funds on a floating rate basis? Let's see.
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Floating rate notes (FRNs) are bonds that pay investors a regular coupon linked to short term interest rates like three or six month Libor. This can suit the investor and issuer alike. The cost of issuance is key to the borrower. Discounts to par value and margins must be taken into account. Find out more about the all in cost.
7th February 2012
The presentation for the discussion group held at Mutual One on 25/1/12 and 3/2/12.
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I’ve always felt uneasy about stress tests, it’s a bit surprising, after all they should provide comfort that, if the unexpected happens we have cover. Are we right to think they strengthen what we do?