Finance 1.1 Flashcards
Pool Yield
This covers all income to master trust, including interest income, interchange, and all fees. Many issuers also include recoveries on charged-off loans.
Principal Amortization Period
Controlled Amortization: Repayment of principal in a fixed number of equal payments. Controlled Accumulation: Accumulation of principal collections in a principal funding account (PFA) and the repayment of principal in a single “soft-bullet” payment on the expected payment date.
Purchase Rate
Purchase rate represents the principal amount of receivables that the trust buys to replace pool paydowns at the end of the monthly collection period, expressed as a percent of the total trust principal balance.
Reserve Account
Should excess spread decline beneath defined levels, there is typically the necessity for the trust to fund a reserve account for the benefit of the Class C investors. See Figure 11 for the typical defined levels and amount of the commensurate required reserve account. The reserve account is typically not funded up front. There is typically no subordination beneath the Class C, and its only credit enhancement is excess spread.
Principal Payment Rate
This is the proportion of principal of the master trust that repays in one month – that is, if a master trust has a 20% payment rate, the cash flows will repay investor principal in five months (100/20 = 5).
Revolving Period
The period in which the master trust buys newly charged receivables. Only interest is paid to investors during this period.
Seller Interest
Seller interest is required by the rating agencies to absorb dilution (amounts related to disputes or returns). The rating agencies require the issuer to allocate an amount of the trust to absorb dilution that is typically 6 to 10% of the pool balance depending on historical dilution numbers.
Soft Bullet
This structure involves a single repayment of principal to investors. The structure requires the accumulation of sufficient investor principal collections, prior to the expected final payment date, to retire the certificates. The collections accumulated will be deposited in an account for the benefit of the certificate holders, and the funds in this account will be invested into eligible investments (generally A-1+/P-1 commercial paper) until the expected final payment date.
custodian
A financial institution that has the legal responsibility for a customer’s securities. This implies management as well as safekeeping.
duration
A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. Duration is expressed as a number of years. Rising interest rates mean falling bond prices, while declining interest rates mean rising bond prices. Investors need to be aware of two main risks that can affect a bond’s investment value: credit risk (default) and interest rate risk (rate fluctuations). The duration indicator addresses the latter issue.
convexity
A measure of the curvature in the relationship between bond prices and bond yields that demonstrates how the duration of a bond changes as the interest rate changes. Convexity is used as a risk-management tool, and helps to measure and manage the amount of market risk to which a portfolio of bonds is exposed.
Yield
Bonds have four yields: coupon (the bond interest rate fixed at issuance), current (the bond interest rate as a percentage of the current price of the bond), and yield to maturity (an estimate of what an investor will receive if the bond is held to its maturity date). Non-taxable municipal bonds will have a tax-equivalent (TE) yield determined by the investor’s tax bracket.
Yield curve
A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. The most frequently reported yield curve compares the three-month, two-year, five-year and 30-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.
Shape of the yield curve
The shape of the yield curve is closely scrutinized because it helps to give an idea of future interest rate change and economic activity. There are three main types of yield curve shapes: normal, inverted and flat (or humped). A normal yield curve (pictured here) is one in which longer maturity bonds have a higher yield compared to shorter-term bonds due to the risks associated with time. An inverted yield curve is one in which the shorter-term yields are higher than the longer-term yields, which can be a sign of upcoming recession. A flat (or humped) yield curve is one in which the shorter- and longer-term yields are very close to each other, which is also a predictor of an economic transition. The slope of the yield curve is also seen as important: the greater the slope, the greater the gap between short- and long-term rates.
Yield curve risk
When the yield curve shifts, the price of the bond, which was initially priced based on the initial yield curve, will change in price. If the yield curve flattens, then the yield spread between long- and short-term interest rates narrows, and the price of the bond will change accordingly. If the bond is a short-term bond maturing in three years and the three-year yield decreases, the price of this bond will increase. If the yield curve steepens, this means that the spread between long- and short-term interest rates increases. Therefore, long-term bond prices will decrease relative to short-term bonds. Changes in the yield curve are based on bond risk premiums and expectations of future interest rates.
