Interest Rates and Bond Valuation

1
Interest Rates and Bond Valuation

• Chapter 6

2
Key Concepts and Skills

• Know the important bond features and bond types
• Understand bond values and why they fluctuate
• Understand bond ratings and what they mean
• Understand the impact of inflation on interest
  rates
• Understand the term structure of interest rates
  and the determinants of bond yields

3
Chapter Outline

• Bonds and Bond Valuation
• More on Bond Features
• Bond Ratings
• Some Different Types of Bonds
• Bond Markets
• Inflation and Interest Rates
• Determinants of Bond Yields

4
Issuer (Seller) of Bonds (Borrower) Bond
Issuer

• Bonds Debt Liability Long-term debt
• 1 Bond usually means the corporation borrows
  1000 (face value)
• Corporations usually issue many Bonds
• Bond Issue
• The total number of bonds that a corporation
  issues at the same time, in denominations of
  1,000 or 5,000 each
• Like any contractual debt
• Bond issuer pays periodic interest to the
  bondholder
• Bond issuer pays the face value back at the end
  of the bond term

5
Issuer (Seller) of Bonds (Borrower) Bond
Issuer

• When you issue a bond, you borrow the money, then
  use the money to buy assets that earn more cash
  than the cash you have to pay out to the
  bondholder
• Leverage
• Example
• Borrow money at 8 interest and buy a machine
  that earns the corporation 13
• The difference between 13 and 8, or 5, is left
  for the stockholders

6
Buyer of Bonds (Lender) Bondholder

• Bonds Asset
• 1 Bond usually means the borrow lends money to
  the corporation or government
• Like any contractual debt
• Bondholders are paid periodic interest for
  loaning money to the corporation and are paid
  back the face value at the end of the bond term
• When you buy a bond you are paying for a future
  steam of cash flow

7
Bond Vocabulary

• Face value par value loan repayment at
  maturity FV
• Annual interest payments annual coupon
• Coupon is from the days when you presented coupon
  to get paid interest
• Annual interest rate (not discount rate) coupon
  rate annual interest rate for calculating
  interest payments annual coupon/face value
• Number of interest payments per year n
• Periodic rate (not discount rate) periodic
  coupon rate (annual coupon rate)/n
• The book is inconsistent with the use of coupon
  (sometimes annual, sometimes semi-annual)
• Periodic interest payment periodic rateface
  PMT
• Years until maturity term of bond years until
  paying back face value and last periodic interest
  payment x
• Maturity specified date on which principal is
  repaid

8
Bond Vocabulary

• Yield To Maturity (YTM) discount rate used to
  value bond i YTM
• YTM Bond Yield Required Return Market Rate
  Rate required in the market on a bond
• YTMs are quoted like APRs
• YTM (Period Discount Rate) n
• Example YTM 10 and bond pays semiannual
  interest payments, then period discount rate
  YTM/n .10/2 .05
• Effective Annual Yield on the Bond (1.10/2)2
  .1025

9
Bonds

• Bonds are interest only loans
• Corporations/Governments borrow money, pay
  interest each period, then pay back face amount
  at end of bond term
• Corporations/Governments plan to issue bonds and
  then set the coupon rate, but by the time they
  actually issue the bond the financial markets
  have already calculated a discount rate for the
  future values that is often different than the
  coupon rate
• Corporations/Governments issue bonds and get the
  cash in (Bonds sold in primary market)
• Many Bonds from Corporations/Governments can be
  traded in the financial markets (Bonds sold in
  the secondary market)

10
Bonds

• Each bond has a price expressed as a percentage
  of the face value
• For example, 103 means 1.03 times the face value
  of the bond
• When the corporation issues the 1,000 face-value
  bond, it receives 1,030
• At maturity, the corporation pays back only the
  face value of 1,000
• 103 and 103 and 1.03 all convey the same meaning
  ? The bond is selling for 3 above the face value

11
Example 1

• On January 1, Cox Construction Corp. issues 750
  10-year bonds with a face of 1000 with a coupon
  rate of 9 at 103, with interest payable
  semiannually, on June 30 and December 31

12
This Bond with its 9 coupon, is priced to yield
8.74 at 1,030
13
But If The Loan Has A Face Value Of 750,000, Why
Did The Bondholder Pay 772,500?
14

• If a corporation offers a rate of interest that
  is higher than the market rate for similar
  securities, investors may be willing to pay a
  premium for the bond
• If a corporation offers a rate of interest that
  is lower than the market rate for similar
  securities, investors will demand a discount on
  the bond

15
What Are Similar Securities?

• Similar securities are bonds or other investment
  vehicles issue by other corporations (different
  than the one being considered) that have similar
  business and financial risks
• The similarities could be
• Similar credit ratings
• Similar business activities
• Similar capital structure

16
Bond Prices
YTM gt Coupon Rate
YTM lt Coupon Rate
17
Definitions

• Premium
• The excess of the price received over the face
  value of a bond
• YTM lt Coupon Rate
• Bond sold at a premium
• Discount
• The amount by which the issue price is less than
  the face value of a bond
• YTM gt Coupon Rate
• Bond sold at a discount

18
The Issuance of Bonds at a Discount Example 2

• On January 1, Muller, Inc., issues 700 6,
  20-year bonds with a face value of 1,000, at 96,
  with interest to be paid semiannually, on June 30
  and December 31

19
This Bond with its 6 coupon, is priced to yield
6.25 at 960
20
Bond Price (Valuation) from Cash Flow Perspective
21
Excel

• Bond Valuation from Bondholders Point of View
• PV(rate,nper,pmt,fv,type)
• PV(YTM/n,nx,PMT,FV,0)
• Bond Valuation from Bond Issuers Point of View
• PV(rate,nper,pmt,fv,type)
• PV(YTM/n,nx,-PMT,-FV,0)
• Finding YTM rate from Bondholders Point of View
• RATE(nper,pmt,pv,fv,type,guess)
• RATE(nx,PMT,-PV,FV,0)

22
Example 3
23
Example 3
24
Example 3
CF Is From Point Of View Of Issuer
25
Bond Values And Why They Fluctuate

• Bond Valuation
• As time passes, interest rates change in the
  market place
• As new information about the company, the
  industry, the economy comes out, interest rates
  change
• As time passes the amount of cash paid out to the
  bondholder does not change
• Because of this the value of the bond will
  fluctuate
• Rates ?, Bond Value ?
• Rates ?, Bond Value ?

26
Graphical Relationship Between Price and YTM
27
Valuing a Discount Bond with Annual Coupons
Payments (Example 4)

• Consider a bond with a coupon rate of 10 and
  coupons paid annually. The par value is 1000 and
  the bond has 5 years left until maturity. The
  yield to maturity is 11. What is the value of
  the bond ? What is the price to you, buying in
  the secondary market?
• Using the formula
• B PV of annuity PV of lump sum
• B 1001 1/(1.11)5 / .11 1000 / (1.11)5
• B 369.59 593.45 963.04
• Answer You would be willing to pay 963.04 cash
  out (negative) for the future cash flows. or
  said this way The bond with a 10 coupon is
  priced to yield 11 at 963.04.

28
Valuing a Premium Bond with Annual Coupons
Payments (Example 5)

• Suppose you are looking at a bond that has a 10
  annual coupon rate and a face value of 1000.
  There are 20 years to maturity and the yield to
  maturity is 8. What is the value of the bond ?
  what is the price to you?
• Using the formula
• B PV of annuity PV of lump sum
• B 1001 1/(1.08)20 / .08 1000 / (1.08)20
• B 981.81 214.55 1196.36
• Answer You would be willing to pay 1196.36
  cash out (negative) for the future cash flows.
  or said this way The bond with a 10 coupon is
  priced to yield 8 at 1196.36.

29
Interest Rate Risk

• The risk that arises for bond owners from
  fluctuating interest rates
• How much interest rate risk a bond has depends
  on
• How sensitive its price is to interest rate
  change
• The sensitivity depends on two things
• All things being equal, the longer the time to
  maturity, the greater the interest rate risk
• All things being equal, the lower the coupon
  rate, the greater the interest rate risk

30
Interest Rate Risk And Time To Maturity
31
Interest Rate Risk To Loss Of Principal (current
price)

• Longer time to maturity
• Small changes in market rate have substantial
  affect on bond value
• Face value is discounted over many periods and
  thus compounding magnifies small interest rate
  changes
• Lower Coupon rate
• Bond with lower coupon rate is proportionally
  more dependent on the face value
• (Bond with larger coupon rate has a larger cash
  flow early in life, so value less sensitive to
  discount rate)

32
Interest Rate Risk Increases At A Decreasing Rate
33
Computing YTM

• Yield-to-maturity is the rate implied by the
  current bond price
• Finding the YTM requires trial and error
  (iteration) if you do not have a financial
  calculator and is similar to the process for
  finding i with an annuity
• If you have a financial calculator, enter N, PV,
  PMT and FV, remembering the sign convention (PMT
  and FV need to have the same sign, PV the
  opposite sign)

34
YTM with Annual Coupons (Example 6)

• Consider a bond with a 10 annual coupon rate, 15
  years to maturity and a par value of 1000. The
  current price is 928.09
• Will the yield be more or less than 10?

35
YTM with Semiannual Coupons (Example 7)

• Suppose a bond with a 10 coupon rate and
  semiannual coupons, has a face value of 1000, 20
  years to maturity and is selling for 1197.93
• Is the YTM more or less than 10?
• What is the semiannual coupon payment?
• How many periods are there?

36
Use One Bond YTM To Find Price Of Another Bond
Example 8
Below Market rate discount
Above premium
37
Bonds and Stocks

• Like stock, bonds bring capital (money) into the
  corporation so that it can invest in profitable
  projects
• Bondholders are creditors
• They have a fixed claim to cash flow
• Stockholders are owners
• They have a residual claim to cash flow

38
Bonds and Stocks

• Debt is not an ownership interest in the firm
• Creditors do not have voting rights
• Interest is tax deductible
• Dividends are not tax deductible
• Unpaid debt is a liability
• Legal claim against assets
• If debt is not paid creditors have the legal
  claim to assets before shareholders
• One of the costs of issuing debt is the
  possibility that you will not be able to make
  interest payments ? creditors force firm into
  bankruptcy ? firm is terminated
• This does not arise when equity is issued
• Corporations try to create hybrid financial
  instruments that are Debt/Equity in order to
  have
• Tax benefits of debt
• Bankruptcy benefits of equity

39
Differences Between Debt and Equity

• Debt
• Not an ownership interest
• Creditors do not have voting rights
• Interest is considered a cost of doing business
  and is tax deductible
• Creditors have legal recourse if interest or
  principal payments are missed
• Excess debt can lead to financial distress and
  bankruptcy

• Equity
• Ownership interest
• Common stockholders vote for the board of
  directors and other issues
• Dividends are not considered a cost of doing
  business and are not tax deductible
• Dividends are not a liability of the firm and
  stockholders have no legal recourse if dividends
  are not paid
• An all equity firm can not go bankrupt

40
Bond Terms and Types

• Bonds Long-term debt
• Privately placed
• Directly placed with the lender
• Public-issue bonds
• Offered to the public
• Finance jargon
• Long-term debt funded debt
• Short-term debt unfunded debt
• Example A firm planning to fund its debt
  requirements may be replacing short-term debt
  with long-tern debt

41
Bond Terms and Types

• Trustee (Investment Bank, other)
• Appointed by the corporation to represent
  bondholders
• Must make sure terms are obeyed
• Must manage sinking fund
• Must represent bondholders in default
• Indenture
• The written agreement between the corporation
  and the lender detailing the terms of the debt
  issue

42
Bond Types

• Registered Form
• The form of bond issue in which the registrar of
  the company records ownership of each bond
• Payment is made directly to the owner of the bond
• Bearer Form
• The form of bond issue in which the bond is
  issued without record of the owners name
• Payment is made to whoever holds the bond
• Uncommon in the USA

43
Bond Types

• Security
• Generic term that means Stocks or Bonds or other
  investment vehicles that are backed by an asset
• A document indicating ownership or creditorship
  a stock certificate or bond
• Dictionary definition of Security
• Something deposited or given as assurance of the
  fulfillment of an obligation a pledge collateral

44
Bond Types

• Debt securities are classified according to the
  collateral and mortgages used to protect the
  bondholder
• Securities Backed By Collateral
• Collateral any asset pledged on the debt (often
  means assets such as stocks or bonds financial
  assets)
• If the borrower does not pay the interest and
  principal to the bondholder, the bondholder can
  take the collateral
• Mortgage Securities
• Debt secured by a mortgage on real assets
  (property, but not cash or inventory) of the
  borrower
• Called
• Mortgage Trust Indenture, or Trust Deed
• Most utility and railroad bonds are secured by a
  pledge of assets

45
Bond Types

• Unsecured Debt
• These creditors have a claim on property not
  otherwise pledged
• Debenture
• Unsecured debt (maturity gt 10 years)
• Most financial and industrial companies public
  bonds are debentures
• Note
• Unsecured debt (maturity lt 10 years)
• Subordinate Debt
• Must give preference to superior debt
• Debt is not subordinate to equity

46
Bond Types

• Sinking Fund
• An account managed by the trustee for the
  purposed of repaying the bonds, or early bond
  redemption
• Bond Issuer must put away some money each period
  to save up in order to pay off the bond
• Protective Covenant
• A part of the indenture limiting certain actions
  that might be taken in order to protect the
  lender
• Negative (thou shalt not)
• Example Limit the amount of dividends paid
• Positive (thou shalt)
• Example CA/CL must be greater than 1.5

47
Bond Types

• Call Provision
• An agreement giving the corporation the option to
  repurchase the bond at a specific price prior to
  maturity
• Call Premium (Pay for the Option)
• The amount by which the call price gt par value
• Example Bond face 1,000, Call Price 1,100
• Call Price goes down over time
• Deferred Call Provision
• Can call only after a certain date
• Call Protected Bond
• Cant be redeemed by issuer
• Make-Whole Call
• When bond called, bondholder gets PV of future
  cash flows at a reasonable rate
• Derivative security jargon
• Call Buy
• Put Sell

48
Financial Markets

• Primary Markets
• Original sale of equity or debt
• Corporation issues security
• Secondary Markets
• After original sale of equity or debt
• You sell/buy security
• Dealer Markets (Over-the-counter markets (OTC))
• Dealers buy and sell for themselves
• Most debt is sold this way
• Example NASDAQ
• Auction Markets (Exchanges)
• Brokers and agents match buyers and sellers
• Most of the large firms equity is sold this way
• Example NYSE

49
Bond Characteristics and Required Returns

• The coupon rate depends on the risk
  characteristics of the bond when issued
• Which bonds will have the higher coupon, all else
  equal?
• Secured debt versus a debenture
• Subordinated debenture versus senior debt
• A bond with a sinking fund versus one without
• A callable bond versus a non-callable bond

50
Bond Ratings And What They Mean

• Bond Rating firms
• Moodys
• Standard and Poors (SP)
• They rate
• The likelihood of default
• The probability that creditors are protected
• They ask they question What is the risk
  associated with the firm issuing the debt?
• They do not rate the probability of bond value
  change due to interest rate risk
• The Debt Crisis of 2007 shows that Ratings can be
  less than accurate
• How do they take risky loans and repackage them
  to get a AAA Super Senior rating? (Thats what
  they did!)

51
Bond Ratings Investment Quality

• High Grade
• Moodys Aaa and SP AAA capacity to pay is
  extremely strong
• Moodys Aa and SP AA capacity to pay is very
  strong
• Medium Grade
• Moodys A and SP A capacity to pay is strong,
  but more susceptible to changes in circumstances
• Moodys Baa and SP BBB capacity to pay is
  adequate, adverse conditions will have more
  impact on the firms ability to pay

52
Bond Ratings - Speculative

• Low Grade
• Moodys Ba, B, Caa and Ca
• SP BB, B, CCC, CC
• Considered speculative with respect to capacity
  to pay. The B ratings are the lowest degree of
  speculation.
• Very Low Grade
• Moodys C and SP C income bonds with no
  interest being paid
• Moodys D and SP D in default with principal
  and interest in arrears

53
Some Different Types of Bonds

• Government Bonds
• Treasury Bill
• Years lt 1
• Treasury Note
• 1lt years lt 7
• Treasury Bonds
• Other
• No default risk
• Treasury issues are exempt from state income tax
  (must pay Fed IT)

54

• U.S. NATIONAL DEBT CLOCK The Outstanding Public
  Debt as of 13 Nov 2007 at 112801 PM GMT
  is
• The estimated population of the United States is
  303,525,093so each citizen's share of this debt
  is 30,039.21. The National Debt has continued to
  increase an average of1.49 billion per day
  since September 29, 2006!

55
Some Different Types of Bonds

• Municipal Bonds Munis
• State and local government debt
• Example Bond to build Highway
• These do have varying degrees of default risk
• Almost always callable
• Coupons exempt from federal income taxes (must
  pay State IT)
• Attractive to high-income/high-tax bracket
  investors
• Because of this the yields are lower
• Which do you (with 25 Fed tax Bracket) prefer
  corporate bond that yields 5, or a muni (with
  comparable risk and maturity) that yields 3.90?
• .039 gt .05(1-.25) .0375

56
Some Different Types of Bonds

• Zero Coupon Bonds
• A bond that makes no coupon payments, and thus is
  initially priced at a deep discount
• Issuer must deduct interest every year
• Tax Benefit ? A deductions for taxes (fewer taxes
  paid ? like cash coming in) even though no cash
  going out (interest expense)
• Bondholder must accrue interest revenue every
  year
• Taxes paid on revenue ? Cash going out (taxes
  paid) even though cash is not coming in (interest
  revenue)
• Regular amortization table is constructed to
  track interest accrual

57
Pure Discount Loans (Zero Coupon)

• Borrow an amount today, then pay back principal
  and all interest at the end of the loan period
• Example US Government Treasury Bills, or T-bills
  (government loans lt 1year)

58
Example 9Pure Discount Loans (Zero Coupon)
59
Example 10Interest Only Bond v. Zero Coupon Bond
60
Interest Only Bond v. Zero Coupon Bond
61
Interest Only Bond v. Zero Coupon Bond
62
Interest Only Bond v. Zero Coupon Bond
63
Floating-Rate Bonds

• Coupon Payments are adjustable
• Rated can be tied to an interest rate index such
  as the Treasury bill interest rate or 30-year
  Treasury bond rate
• Rate and payments are adjusted periodically
• Holder may have the right to redeem the note at
  par on the coupon payment date after some
  specified amount of time
• This is called a Put Provision
• The coupon rate has a floor and ceiling
• Capped or Collared means they have an upper
  and lower barrier

64
Other Bonds

• Income Bonds
• Coupon payments are dependent on the company
  income
• Convertible Bonds
• Debt that can be converted to a fixed amount of
  equity anytime before maturity at the holders
  option
• Half Debt half equity?
• How do you list it on the Balance Sheet?
• Put Bond
• Allows holder to force the issuer to buy the bond
  back at a stated price (reverse of a call)
• CoCo and NoNo Bonds
• These have many features that require complex
  valuing techniques. Because the features can be
  valuable to the bondholder, the YTM could be
  negative!

65
Bond Markets

• Because the bond market is almost entirely OTC,
  it has little or no transparency (cant see a
  great deal of Buy/Sells to gage market value of
  bonds)
• US Treasury market is the largest security market
  in the world
• Terminology
• Bid Price
• The price a dealer is willing to pay for a
  security
• Ask Price
• The price a dealer is willing to take for a
  security
• Bid-ask spread
• Bid Ask Dealers Profit

66
The Impact Of Inflation On Interest Rates

• Inflation
• Increase in price over time
• Example
• Price of milk now 3.39/gal.
• Price of milk in 1 year 3.56/gal.

67
Inflation and Interest Rates

• Real Rates
• Base interest rate that does not take inflation
  into consideration
• The percentage change in buying power
• Interest rates or rates of return that have been
  adjusted downward from the nominal rate for
  inflation
• Nominal Rates
• Interest rates or rates of return that have not
  been adjusted downward for inflation
• change in the number of dollars you have
• The nominal rate of interest includes our desired
  real rate of return plus an adjustment for
  expected inflation

68
The Fisher Effect (Irving Fisher)

• The Fisher Effect defines the relationship
  between real rates, nominal rates and inflation
• R r h rh
• r (R-h)/(1h) (1R)/(1h) - 1
• (1 R) (1 r)(1 h)
• R nominal rate
• r real rate
• h expected inflation rate
• Approximation
• R r h

69
Example 11
70
Example 6.6

• If we require a 10 real return and we expect
  inflation to be 8, what is the nominal rate?
• R (1.1)(1.08) 1 .188 18.8
• Approximation R 10 8 18
• Because the real return and expected inflation
  are relatively high, there is significant
  difference between the actual Fisher Effect and
  the approximation.

71
The Fisher Effect

• Real rate is hard to observe directly, so we
  observe it indirectly
• r (R-h)/(1h) (1R)/(1h) - 1
• Real Rate is fairly constant
• Take into consideration taxes
• r (R(1-taxrate)-h)/(1h)

72
The Term Structure Of Interest Rates And
Determinants Of Bond Yields

• The risks associated with loaning money are added
  into a base interest rate known as the real rate

73
Bond Yields represent 6 effects

• Some Components of Interest Rates
• Real Rate
• Inflation Premium
• Interest Rate Risk Premium
• Default Risk Premium
• Taxability Premium
• Liquidity Premium

74
Real Rate

1. Compensation investors demand for foregoing the
   use of their money
2. Basic component underlying every interest rate
3. When real rate high, all rates tend to be high
4. Doesnt really determine shape of term structure
   (overall effect)

75
Inflation Premium

1. The portion of a nominal interest rate that
   represents compensation for expected future
   inflation
2. Very strongly influences the shape of term
   structure
3. Inflation expected increase ? structure upward
4. Inflation expected decrease ? structure downward

76
Interest Rate Risk Premium

1. Compensation demanded for bearing interest rate
   risk
2. longer-term bonds have a much greater risk of
   loss resulting from changes in interest rate than
   so short-term bonds
3. This premium increases at a decreasing rate

77
Term Structure Of Interest Rates (Based On Pure
Discount Bonds)

• This shows the relationship between short and
  long-term interest rates
• Tells us what the nominal interest rates are on
  default-free (Treasury), pure discount securities
  of all maturities
• This shows the relationship between nominal
  interest rates on default-free, pure discount
  securities and time to maturity
• These rates are pure because they involve no
  risk of default
• The term structure tells us the pure time value
  of money for different lengths of time
• Upward sloping long-term rates gt short-term
  rates
• Downward sloping long-term rates lt short-term
  rates

78
Upward-Sloping Yield Curve
79
Downward-Sloping Yield Curve
80
Term Structure Of Interest Rates

• Assumes
• Real Rates remain constant
• Inflation linear
• Rates could be Humped
• Rates increase at first, but then decline as we
  look at longer-termed notes

81
Treasury Yield Curve

• A plot of the yields on Treasury Notes and Bonds
  relative to Maturity
• Treasury Yield Curve and the Term Structure Of
  Interest Rates re almost the same thing
• The difference is
• Treasury Yield Curve
• Based On Coupon Bond Yields
• Term Structure Of Interest Rates
• Based On Pure Discount Bonds

82
Treasury Yield Curve (Coupon Bond Yields)
83
Default Risk Premium

1. Bonds other than Treasury Credit risk/default
   risk
2. The portion of a nominal interest rate or bond
   yield that represents compensation for the
   possibility of default
3. Lower rated bonds have higher yields

84
Taxability Premium

• The portion of a nominal interest rate or bond
  yield that represents compensation for
  unfavorable tax status
• Remember municipal versus taxable
• Bonds that are taxed at both the state and
  Federal level are less favorable than a bond that
  is only taxed at the Fed. level

85
Liquidity Premium

• The portion of a nominal interest rate or bond
  yield that represents compensation for a lack of
  liquidity
• Liquidity
• How quickly an asset can be converted to cash
• Example
• Maybe the bond is hard to sell quickly and
  therefore would require a premium for that lack
  of liquidity
• Less liquid bonds have higher yields than more
  liquid bonds

86
Three Principles in Bond Finance

• Rates are inversely related to price
• Market rate ?, Bond Price ?
• Par, Discount, Premium
• Market rate Coupon Rate
• Bond sells at Par or Face Value
• Market rate gt Coupon Rate
• Bond sells at a Discount
• Market rate lt Coupon Rate
• Bond sells at a Premium
• The more years there are to maturity, the higher
  the interest rate risk becomes
• Interest rate risk to loss of principal

87
Bond Vocabulary

• Current Yield
• Annual Interest Payment/Closing Price
• Not equal to YTM (unless bond sells for par) it
  does not include the capital gain from discounted
  face value (principal)
• Premium Bond
• CY gtYTM
• Discount Bond
• CY ltYTM
• In all cases ?(Current Yield) (Expected
  one-period capital gain/loss yield of the bond)
  must be equal to the YTM

88
Securitization

• Securitization The process of Securitization
  involves the collection or pooling of loans and
  the sale of securities backed by those loans
  (Cash flows in loan)
• Whereas, Banks once made loans and kept them on
  their books, now they can initiate loans and then
  sell the loans to someone else.
• Securitization packaging a set of cash flows
  and then selling claims (bonds or other) against
  them
• Claims asset backed securities
• This means that the cash is the asset that backs
  it