Mortgage Pass-through Security: shares in a pool of mortgages sold by a financial institution or government agency, where mortgage payments less fees are passed through to the security investors. A mortgage pass-through security is a type of MBS. Following issuance, pass-throughs can be resold by investors on the secondary market. Pass-through Rate = Mortgage Rate […]

# Fixed Income Securities

## Mortgage Cash Flow Characteristics

Simply put, a mortgage is a debt instrument that is backed by real estate as collateral. Fully Amortized Mortgage Loan: Borrower makes an equal monthly payment that includes an interest component and a principal repayment component. In the early years of the repayment schedule, interest makes the largest share of the monthly payment, as principal […]

## CFA Level 2: Fixed Income Part 2 – Introduction

This tutorial is the second of two parts covering fixed income. The subject of asset backed securities (of which mortgage backed securities are technically a large subset) may sound intimidating to some candidates, but this module is actually heavily conceptual. Beyond memorizing a few formulas, there are a lot of definitions and ideas to absorb. […]

## How to Price Convertible Bonds?

Some common momentum indicators include: Convertible Security: Debt security that can be converted into a specified number of shares of the issuer’s common stock at the option of the security owner. Exchangeable Security: Debt security that can be converted into a specified number of common stock shares for a company other than the exchangeable security […]

## Valuing an Option Embedded Bond using Binomial Interest Rate Tree

The Binomial Interest Rate Tree An issuer’s bonds can be valued with a binomial interest rate tree. In order to do this, the analyst will need to: Calculate the spot rate curve for the borrower based on that company’s most recently issued debt. Use the spot rate curve to calculate forward rates for the issuer. […]

## Benchmark Yield Spreads

Whereas stocks have their ratio comparables with similar companies and certain indexes, bonds have yield spreads. A bond may be considered under-valued or over-priced based on its yield spread above a relevant benchmark yield. Nominal Spread: This is the difference in yield between the yield to maturity of a bond and the yield to maturity […]

## How to Calculate Interest Rate Volatility?

Step 1: Calculate yield change ratios as follows: YCR t = r t / r t-1 The yield change ratios are typically daily ratios (i.e., today’s yield or interest rate divided by yesterday’s) that are annualized later at a later step in the process. Step 2: Convert yield change ratios into a continuously compounded return […]

## Key Rate Duration

Effective duration calculates the approximate change in a bond’s price given a 100 basis point (1%) move in interest rates as part of a parallel shift in the yield curve. When the yield curve shifts in a non-parallel manner, the portfolio’s effective duration cannot be used to estimate the change in portfolio value. Key rate […]

## Theories of the Term Structure of Interest Rates

The shape of the yield curve has two major theories, one of which has three variations. Market Segmentation Theory: Assumes that borrowers and lenders live in specific sections of the yield curve based on their need to match assets and liabilities. The theory goes further to assume that these participants do not leave their preferred […]

## LIBOR Swap Rate Curve

The London Inter-bank Offered Rate (LIBOR) is the U.S. dollar borrowing rate for high quality banks among one another, outside the U.S. Swap Rates: The fixed interest rate in a swap contract where two parties have agreed to exchange fixed rate and floating rate payments based on a notional principal. LIBOR is commonly used as […]