Literature review on Market-based securities in US

Discuss about the MBS market in the US?

In the contemporary capital market, there is various investment option are available that are being engineered by the financial manager. Capital market gives the investors the opportunities to invest in several investment avenues like equity, debt, futures, forwards bonds etc.   Since 20008, most of the investors worldwide have lost faith in the equity market because of its high volatility in the products (Chiquier et al. 2004). There are several marketed securities available for the investor one of them is fixed income. Fixed income securities is very much different from the equity form of investment because the borrower of which ha o pay the fixed payments on fixed rate on fixed period of time.  The study will focuses on the market based securities and the fixed payment securities in US (Clemmitt, 2007). Apart from that study will also focus on the secondary research on the MBS via various capital market sites like Bloomberg.

Since, 2008 financial turmoil, there has been several number of development has been made like reformed regulations, modifying the market structure of US and introducing the technological improvement in the capital market.   There are several mortgage based securities are available in the US market. Mortgage backed securities are very much based on the loan.  Initially, the banks or company uses the home loan then the bank sells the same loan to an investment banks or an agency like Freddie Mac or Fannie Mae (Fabozzi and Mann, 2005). The MBS is very much sold  by the government agencies in US very much attract the investors because of the money back guarantee from the Federal Government.  Thus, the investors rely on these back securities because the investors know that they are going to receive the hefty amount from money back by the Fannie Mae and Freddie Mac MBS. Here the agency issues MBS and guarantees to pay the principle along with the interest to the holders of the MBS (Goodman, 2008).

With the help of types of Mortgage based securities helps the company to get in depth learning of the structure of US MBS market:

Figure 1: Types of the US MBS market structure

(Source: Green, 2013, pp-23)

MBS market is very much complex and one of the most difficult structure of model was mortgage basic called pass through certifications. Here the mortgage holder gets the actual shares of its investment from principal amount to the interest’s amount.

As noted by Furfine (2010), on the other hand, major or advance products are called derivate products. Derivate products are being sold in the secondary market on the basis of underlying value of the total asset.  These are also known as the tranches which only is traded between 1-3 years of payments (Lea et al. 2004).  Some of the investor sin US are very much willing to take the risk worth of 5-7 years of non payments and are looking for higher interest paid reward. The products can be of higher risk because the borrower may fail or not pay the interest amount (Nguyen, 2011).

Types of Mortgage-based securities

Mortgage based securities are being are initially introduced by the US in order to bring revolution in housing baking and mortgage business.  This has helped the common man to buy homes (Stone and Zissu, 2005).  In year 2000-2005, real estate is one of the booming industry most of the banks and mortgage companies has made the loan with no done payments has made the people to afford mortgages which really couldn’t afford.  This has tended the seller of loans that, they can sell the loans irrespective of the default in payments which leads to the housing bubble in US market (Tuckman, 2002).

As noted by Manola and Urosevic (2010), Fixed rates and variables rates of MBS is been determined with the help of various factors. Fixed rate are been determined majorly on the bonds yielding of the bonds. The reason because most of the mortgages are been handled at once by anyone as in return the customer customers receive the mortgage money. Bank usually lends the money to the customers and sells back the mortgage to other investors with smaller returns. 

   
Figure 2: Fixed and variable MBS

(Source: Antinolfi and Brunetti, 2010, pp-242)

On the contrary, Zhou (2010), variable rates of MBS are based on the prime rate which changes as per bank to bank. Some of the major factors which may impact the MBS rate are because of inflations, growth and balance of import and export along with Foreign exchange.  Raising the prime rate decreases the inflation are and also the growth.

Variable rate =Prime rate –Spread -30 days LIBOR= Discount

 As discussed by LaCour-Little et al. (2011), in 2006 there was housing bubble burst that leads to subprime crisis in mortgage industry which finally created 2000 financial crisis because of the huge losses. Some of the major agencies who offer the MBS are given below:

Ginnie Mae: Ginnie Mae was the first company that has introduced the MBS in 1968 by the US government national Associations. Ginnie Mae is one of the governmental organization that issued the MBS back by the credit of US government (Ambrose and Sanders, 2008).  Ginnie Mae is ben guaranteed payment of the principal amount along with principal has been one of the pillar of the constructs irrespective of the default in mortgage payments by the borrower (Lugo, 2014).

Fannie Mae: It another major company who issues the MBS and are very much has ethical responsibility of the US government to rate the credit value of the mortgage.  The FNMA (Federal National Mortgage association) is very much work on the basis of the treasury regulation of the money market guarded the federal bank of America (Antinolfi and Brunetti, 2010).  

Freddie Mac:  It is stockholder owned government sponsored corporation that has been formed in order to enhance the mortgage credit and give quick liquidity.  It is owned by the federal home loan Mortgage associations and has line of credit with the government of America (Cantor and Hu, 2009).

Both of the Fannie Mae and Freddie Mac are being offering the high returns MBS in compare to the Ginnei Mac. Ginnie has lower credit quality in compare to the Both Fannie Mae and Freddie Mac.

Fixed and variable rates of MBS

Mortgage backed securities are very much similar to the fixed income trading.  As per the report of Bloomberg , mortgage backed securities went wrong because of lack of transparency in the approach and complex structure leads to the 2000 financial subprime crisis in housing bubble burst (Mooradian and Pichler, 2014).  The mortgage backed securities was initially authorized in 1968 as per the charter act. This carter act has been formed by the Fannie Mae.  This has helped the banking sector to sell the loans and mortgages in order to create liquidity and give loan to others. Fannie Mae did not know that this ethical way of funding the people dream will lead to creates poor lending practices (Zhou, 2010).  Most of the banks in US like JP Morgan Chase and Lehman brother are   understood that they wouldn’t have to pay the loan amount.

As per the Bloomberg USD MBS Bond index are given below as per the 2014 report:

As per the description of Bloomberg USD bond index shows that market value  of the yield to maturity is 2.36%  as per the Ginnie Mae , Fannie Mae and Freddie Mae combined ratings. These ratings of the US bond market very much shows that, US MBS is very weaker in performance after the 2008 financial crisis.  There are numerous occasions where the number of average life of the MBS is around 5.22 years. Therefore there is no 1-3 year of the MBS currently in the USD market as per the Bloomberg report.

Bloomberg indexes are very much gives the sum total of the world indexing performance as per the shares globally. Bloomberg indexes helps to meet the borrower and the investor needs of the MBS along with other financial products.  The indexes of Bloomberg gives the investor’s world class data that helps them to compare and contrast the performance of the world-class MBS offered in US and other nations.

Mortgage back securities performance in compare top world during 2008 crisis is given below:

(Source: www.bloomberg.com, 2015)

During 2008, crisis as per the Bloomberg report, Merrill Lynch reportedly has been confirmed the net loss worth of more than $ 8.6 billion that broke the stock market down. Then there is collapse of the one of the strongest housing mortgage company Lehman brothers who have collapsed due to increase in the default in payments and price of real estate is being lowering done which lead to global catastrophe (Zhou, 2010).  As per the bloom index USD MBS is been going through rough phase that point of time. During that period of time, MBS has been able to garnered controversy which tends to lend the subprime crisis. MBS is been one of the part of the subprime lending that start rooting the housing bubble bursts. Since then the government of treasury has changed the US MBS bond norms and brought more  transparency and more of clear concept rather the complex structure which turns into  the nightmare for the US and rest of the world (Lugo, 2014).

Agencies offering MBS in US

Graph 2: Effective yield of US Bloomberg Index bond

(Source: www.bloomberg.com, 2015)

As per the graph shown the above graph, Bloomberg has shown that comparative analysis of the bonds and MBS which is quite blooming again. Among the bonds corporate bonds has high yielding  which is currently running 52 weeks  but the company is not been able to gain the large market share for federal reserve’s rates  shows one of the major difference in  the bonds and the MBS index. The yielded ration of MBS has been improved since 2008 that has now become 2.36% (Lugo, 2014).  The Bloomberg report also shows that, most of the bonds which are being offered by the Corporate like JP Morgan chase and Morgan Stanley are some of the major bonds that have been growing compare to the other bonds. However, there is huge risk in the compare bonds ion compare to the MBS bonds which are much safer as the guarantor are the US government and  agencies like Ginni Mae and Freddie Mac (Stone and Zissu, 2005).

 The Bloomberg report also shows that, MBS rate is still improving because of the backing and supporting of the bond by ensuring the money back guarantee by the US treasury. This has been one of the major reason for strengthen the MBS in recent times.  US municipal bonds are being one of the major financial bonds that have been improving and US government is backing up strongly in order to gain the large market (Goodman, 2008). One of the most important part of the Bloomberg Indexes are being one of the  global ratings of the bonds  which is fair and are against the any of the influence. The data given in Bloomberg are very real and in reference to change in price, data and technology is known are  helpful for the investors and private equity firm in their decision making where or not to invest in MBS. Mortgagee back securities is been one of the strong pillar of the financial avenues in US market because of its less volatility in nature (Clemmitt, 2007).

The report of the MBS is basically calculated by the Bloomberg is based on the market place, fixed income security and sources of revenue of the MBS. Some of the major benefits of the MBS are given below:

High Credit Quality: One of the benefit of the MBS is being it is very high quality debt as it has been credited by the government own agencies like Ginni Mac and Freddie Mac.  It is been own and control by the US government who are responsible for payment of the principle and interest of investors (Ambrose and Sanders, 2008). Federal agency gives his nodding which is why it becomes one of the high credit qualities.  Major MBS are AAA based bonds in compare to agency or corporate bonds.

Attractive ROI:  MBS is very much low risky affairs in compare to the equity or the other forms of bonds. It also gives the lucrative earnings because it is very much backed by the US government and are paid on the monthly basis.  It is different from the other bond where the lump sum amount is being paid in compare to other bonds.  Apart from that, this also gives the company opportunities to invest more than 2 years which leads the MBS to reach and attract the large audience (Antinolfi and Brunetti, 2010).  

Discussion on the Market-Based Securities (MBS)

Monthly based income: Finally, one of the major attractions of MBS is because of the monthly based payment which is why most of the investors prefer the MBS in compare to fixed income trading. The monthly income helps the investors to clear their entire expenses and becomes of the sources of incomes.

However ,some of the major risk which prevails  within MBS as per the Bloomberg are as the credit standard was low in 2000 leads the lenders to high risky loans instead of higher quality loans that remove their liability (Ambrose and Sanders, 2008).  Besides that, there is risk in mortgage pass through because of the involvement in credit risk, liquidity risk, interest rate risk and other risk. The credit risk here shows that, uncertainty in the payments by the borrower how long they will continue to pay off. Mortgage backed securities can be frustrate the investors because of low interest rates.  If the interest rates are being high then homeowners are going to hold the mortgages of the life (Lea et al. 2004). It gives the lower returns in compare to share or other derivates products. Besides that, Ginnie Mae sells minimum $25000 of the shares. However, Freddie Mac and the Fennie Mac MBS are being sold within minimum $1000.  Lastly, the information from the Bloomberg shows that MBS is fully taxable unlike government bonds which is not taxable (LaCour-Little et al. 2011).

Conclusion:

From the above study, it has been found that, MBS is been one of the major investment areas that has been offered by the US governmental agencies. Some of the major agencies who are into the business of selling of the MBS are Freddie Mac, Ginni Mae and Fannie Mae. The rate of variable and fixed MBS is different because of the external economic factors like Inflations, GDP and import and export and Foreign exchange. Apart from that, MBS is very different from the Fixed income trading because of fixed income trading is being paid off at once lump sum and the MBS is paid on a monthly basis. The above discussion has also concluded that, MBS is been one of the reason for housing bubble buret in US as because of the poor mortgage backed securities.

Reference List

Books

Chiquier, L., Hassler, O. and Lea, M. (2004). Mortgage securities in emerging markets. Washington, D.C.: World Bank, Financial Sector Operations and Policy Dept.

Clemmitt, M. (2007). Mortgage crisis. Washington, D.C.: CQ Press.

Fabozzi, F. and Mann, S. (2005). Securities finance. Hoboken, N.J.: John Wiley & Sons.

Goodman, L. (2008). Subprime mortgage credit derivatives. Hoboken, N.J.: John Wiley & Sons.

Green, R. (2013). Introduction to Mortgages & Mortgage Backed Securities. Burlington: Elsevier Science.

Lea, M., Chiquier, L. and Hassler, O. (2004). Mortgage securities in emerging markets. [Washington, D.C.]: [World Bank].

Nguyen, T. (2011). Fraud and the Subprime Mortgage Crisis. El Paso: LFB Scholarly Pub. LLC.

Stone, C. and Zissu, A. (2005). The securitization markets handbook. Princeton, NJ: Bloomberg Press.

Tuckman, B. (2002). Fixed income securities. Hoboken, N.J.: Wiley.

Journals

Ambrose, B. and Sanders, A. (2008). Commercial Mortgage-backed Securities: Prepayment and Default. SSRN Journal.

Antinolfi, G. and Brunetti, C. (2010). Economic Volatility and Financial Markets: The Case of Mortgage-Backed Securities. SSRN Journal.

Cantor, R. and Hu, J. (2009). Deal Sponsor and Credit Risk of Asset-Backed and Mortgage-Backed Securities. SSRN Journal.

Furfine, C. (2010). Deal Complexity, Loan Performance, and the Pricing of Commercial Mortgage Backed Securities. SSRN Journal.

LaCour-Little, M., Park, Y. and Green, R. (2011). Parameter Stability and the Valuation of Mortgages and Mortgage-Backed Securities. Real Estate Economics, 40(1), pp.23-63.

Lugo, S. (2014). Discretionary Ratings and the Pricing of Subprime Mortgage-Backed Securities. SSRN Journal.

Manola, A. and Urosevic, B. (2010). Option-based valuation of mortgage-backed securities. Ekon. an., 55(186), pp.42-66.

Mooradian, R. and Pichler, P. (2014). The Design of Mortgage-Backed Securities and Servicer Contracts. SSRN Journal.

Mooradian, R. and Pichler, P. (n.d.). The Design of Mortgage-Backed Securities and Servicer Contracts. SSRN Journal.

Zhou, T. (2010). Indifference valuation of mortgage-backed securities in the presence of prepayment risk. Mathematical Finance, 20(3), pp.479-507.

Websites

Fund, V. (2015). VMBIX Quote – Vanguard Mortgage-Backed Securities Index Fund. [online] Bloomberg. Available at: https://www.bloomberg.com/quote/VMBIX:US [Accessed 7 Mar. 2015].

Fund, V. (2015). VMBSX Chart – Vanguard Mortgage-Backed Securities Index Fund. [online] Bloomberg. Available at: https://www.bloomberg.com/quote/VMBSX:US/chart [Accessed 7 Mar. 2015].

Index, B. (2015). BMBS Quote – Bloomberg USD MBS Bond Index. [online] Bloomberg. Available at: https://www.bloomberg.com/quote/BMBS:IND [Accessed 7 Mar. 2015].