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FEBRUARY 2013
February 2013
February 2013
horizon. Make sure not to hold on to this trade too long because there will be a rollover charge on the trade (this occurs when the short-currency has a higher interest rate than the long-currency) of around 0.3% p.a. but at 10x leverage is equal to 3%. This article was written on January 04, 2013, when: EUR/NOK traded at 7.2576 USD/NOK traded at 5.5897 Disclosure: I may or may not take a position in this trade in the near future. All data is sourced from CNBC or Yahoo! Finance.
February 2013
Mortgage-baCKed SeCuritieS
Theyre back!
By Tony Murphy
Not too long ago, almost everyone thought mortgage-backed securities were evil. After all, the securities, backed by mortgages including subprime home loans, nearly wrecked the U.S. financial system in 2008. Well, theyre back, and banks are profiting. Mortgage-backed securities (MBS) are investments whose value is secured, or backed, by the value of an underlying bundle of mortgages. When investors buy an MBS, they are not buying the actual mortgage. Instead, they are buying a promise to be paid the return that the bundle will receive. Banks make their money from taking the mortgages and bundling them into bonds that they then sell to investors. After they bundle the mortgages into bonds, the banks transfer nearly all of the loans to government-controlled entities like Fannie Mae or Freddie Mac. These entities, in turn, guarantee the bond investors a steady stream of payments. The banks that originated the loans take the guaranteed bonds and sell them to investors. The higher the mortgage rate paid by homeowners and the lower the interest paid on the bonds, the bigger the profit for the bank. For example, a bank may lend money to homeowners at a 3.5 percent interest rate. After bundling those mortgages, the bank could then sell them in bonds that have an interest rate of 2.5 percent. This 100 basis point difference is known as the MBS spread. The banks pocket this markup when they sell the bonds. The MBS spread has been historically high in recent months, as mortgage rates have fallen much more slowly than the bond interest rates. From January to June 2012, the average difference between the two rates was 1.1 percent. From 2000 to 2010, it was about 0.5 percent. For investors, the lower bond yields are still attractive because long-term interest rates are close to zero. For banks, the extra mortgage revenue has covered new costs. As a result of more stringent conditions since the housing bust, bankers are required to be more diligent in approving loan applications, which has made MBS issuance more expensive. Indeed, the mortgage bond market is very different from what it was before the financial crisis. For one, it is much smaller. Very few residential mortgage-backed securities have been issued since the crisis. The market, at $1.3 trillion, is half the size it was at its peak. However, as housing recovers, so will demand for mortgage-backed securities.
[CreditS]
Kevin goldfarb Editor-in-Chief
Vice President of Financial Analysis
Shruti Shah
Managing Editor