Nominal yield

Abstract: This article shows that, in the presence of transaction costs payable by borrowers on refinancing, it is possible to construct a separating equilibrium in which borrowers with differing mobility select fixed rate mortgages (FRMs) with different combinations of coupon rate and points. We also show that, in the absence of such costs, no such equilibrium is possible. This provides a possible explanation for the large menus of FRMs typically encountered by potential borrowers, and suggests that the menu available at the time of origination should be an important predictor of future prepayment. We numerically implement the model, developing the first contingent claims mortgage valuation algorithm that can quantify the effect of self-selection on real contracts in a realistic interest rate setting. The algorithm allows investors to account for self-selection when valuing mortgages and mortgage-backed securities. It also, for the first time, allows lenders to determine the optimal points/coupon rate schedule to offer to a specified set of potential borrowers, given the current level of interest rates.

Abstract: The apparent inability of analysts to explain the unusual bond price pattern reflects an incomplete understanding of the mathematics of bond prices While price volatility is related to the time structure of a bond, it is not mathematically related to term to maturity in any simple way However, the high market rates of interest in recent years have given greater practical importance to the inverse relationship between term to maturity and change in bond price Duration is a concept first introduced by Frederick Macaulay to provide more complete summary information about the time structure of a bond than term to maturity The inverse relationship between duration and coupon makes a higher coupon bond a shorter term bond than a lower coupon bond of the same maturity The longer the term to maturity, the higher the coupon rate, or the higher the market yield, the more important are the coupon payments relative to the maturity payment

Abstract: This paper applies a contingent claims approach to examine the duration of a zero coupon bond subject to default risk. One replicating portfolio for a default-prone zero coupon bond contains a long position in the default-free asset plus a short position in a put option on the underlying assets. The duration of the bond is shown to be a weighted combination of the duration of the default-free bond and the put option. The duration is less than maturity and is not an immunizing duration. The technique is then extended to subordinated debt. DURATION IS A SUBJECT of much concern to researchers and bond portfolio managers. In the last five decades, the literature on duration has grown from a simple explication of its property as a measure of average maturity (Macaulay (1938)) to sophisticated strategies such as funding multiple liabilities (Fong and Vasicek (1984)). Duration, however, is not without its critics. For example, the simplest framework for a duration model, a world of parallel yield curve shifts, is not only an unlikely state of nature but is also inconsistent with equilibrium (Ingersoll, Skeleton, and Weil (1978)). Fortunately, however, Bierwag, Kaufman, and Toevs (1982) have shown that a given duration measure, even the simplest one, can be consistent with equilibrium, as well as disequilibrium, processes. Thus, it should not be too surprising that, in spite of its limitations, duration is still widely used today in bond portfolio management. Although progress and, in some cases, solutions have been developed for a number of practical and theoretical problems in duration, many remain unsolved. For example, the effect of default risk on duration is currently unknown. It hardly seems wise to assume that default-free duration strategies will be appropriate for default-prone markets. In a world of contingent claims contracting, however, investors can separate default effects from interest rate effects. Given the large size of the market for default-prone bonds, it is obvious, nonetheless, that many investors choose to accept both risks.1 Therefore, the extent to which default premia are affected by interest rates, and, thus, have a potential impact

Abstract: Mortgages are long-term nominal loans. Under incomplete asset markets, monetary policy is shown to affect housing investment and the economy through the cost of new mortgage borrowing and the value of payments on outstanding debt. These channels, distinct from traditional transmission of monetary policy, are evaluated within a general equilibrium model. Persistent monetary policy shocks, resembling the level factor in the nominal yield curve, have larger effects than transitory shocks, manifesting themselves as long-short spread. The transmission is stronger under adjustable- than fixed-rate mortgages. Higher, persistent, inflation benefits homeowners under FRMs, but hurts them under ARMs.