Prime Mortgage

Prime Mortgage

· A type of mortgage with a low risk of defaulting on the loan and are offered to borrowers with good credit records and a monthly income at least three to four times greater than their monthly housing expenses-mortgage payments plus taxes and other debt payments.
· It is a high-quality mortgage that meets the standards set by Fannie Mae and Freddie Mac and is eligible for purchase or securitization in the secondary mortgage market.
· Prime mortgages are less costly to borrowers and put banks at a lower risk of non-payment.
· Prime loans are much less likely to have a prepayment penalties.
· It is more difficult for home buyers to get approved for prime mortgages, especially if they have minimal income and/or a mediocre credit history.
· Borrowers with problematic credit records more frequently accept mortgages with terms that are not favorable to them, because they aren’t able to qualify for prime loans.
· Prime mortgage also referred as conventional mortgage . The conventional mortgage gets its name because it is the most common form of financing the purchase of a house and is “conventional”, i.e. not insured or guaranteed by the HUD, Veterans’ Administration or the Federal Housing Agency (FHA).
· A Prime mortgage usually does not go over the appraised worth or purchase price of the property by 75%, whichever is the least of the two. It is also the norm for a Prime mortgage to be a long term loan of thirty years since buying a home is considered a lifetime investment.

BANK FOR INTERNATIONAL SETTLEMENTS - BIS

Term

BANK FOR INTERNATIONAL SETTLEMENTS - BIS

Meaning
The Bank for International Settlements (BIS) is an international organization which fosters international monetary and financial cooperation and serves as a bank for central banks.
The BIS fulfils this mandate by acting as:
· a forum to promote discussion and policy analysis among central banks and within the international financial community
· a centre for economic and monetary research
· a prime counterparty for central banks in their financial transactions
· agent or trustee in connection with international financial operations
The head office is in Basel, Switzerland and there are two representative offices: in the Hong Kong Special Administrative Region of the People's Republic of China and in Mexico City.
Established on 17 May 1930, the BIS is the world's oldest international financial organization. Essentially, the BIS is a central bank for central banks; it does not provide financial services to individuals or corporations.
As its customers are central banks and international organizations, the BIS does not accept deposits from, or provide financial services to, private individuals or corporate entities. The BIS strongly advises caution against fraudulent schemes.

Subprime Mortgage

Subprime Mortgage

· Subprime mortgage market lends money to people who don’t meet the credit or documentation standards for ordinary mortgages or who has poor credit history.
· Subprime borrowers often have credit problems or low incomes, there’s a greater chance that they won’t pay back their debts, making subprime mortgages inherently risky for lenders. To compensate for this added risk, banks and other lenders charge higher interest rates on subprime mortgages.
· Subprime mortgages are considered less borrower-friendly and put banks at higher risk of non-payment.
· The subprime rate offered by the lender can vary from lending institution to institution.
· Subprime mortgages are more frequently adjustable rate (ARM) than fixed, the Federal Reserve web site states that over 2/3rds of such loans are adjustable. This increases the possibility that borrowers will be incapable of paying the differences if interest rates undergo an unexpected increase.

SOVEREIGN DEBT

Term

SOVEREIGN DEBT

Meaning
A debt instrument guaranteed by a government.
Under the doctrine of sovereign immunity, the repayment of sovereign debt cannot be forced by the creditors and it is thus subject to compulsory rescheduling, interest rate reduction, or even repudiation. The only protection available to the creditors is threat of the loss of credibility and lowering of the international standing (the sovereign debt rating) of the country which may make it much more difficult to borrow in the future.

Example
In early 2010 fears of a sovereign debt crisis or the 2010 Euro Crisis developed concerning some countries in Europe including: Greece, Ireland, Spain, and Portugal. This led to a crisis of confidence as well as the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other EU members, most importantly Germany.
Concern about rising government deficits and debt levels across the globe together with a wave of downgrading of European Government debt has created alarm in financial markets. The debt crisis has been mostly centred around recent events in Greece, where there is concern about the rising cost of financing government debt. On 2 May 2010, the Eurozone countries and the International Monetary Fund agreed to a €110 billion loan for Greece, conditional on the implementation of harsh Greek austerity measures. On 9 May 2010, Europe's Finance Ministers approved a comprehensive rescue package worth almost a trillion dollars aimed at ensuring financial stability across Europe.

Repurchase agreement – Repo

Repurchase agreement – Repo

A contract in which the seller of securities, such as Treasury Bills, agrees to buy them back at a specified time and price. also called repurchase agreement or buyback

LIQUIDITY ADJUSTMENT FACILITY - LAF

LIQUIDITY ADJUSTMENT FACILITY - LAF

Meaning
A tool used in monetary policy that allows banks to borrow money through repurchase agreements. This arrangement allows banks to respond to liquidity pressures and is used by governments to assure basic stability in the financial markets.
Liquidity adjustment facilities are used to aid banks in resolving any short-term cash shortages during periods of economic instability or from any other form of stress caused by forces beyond their control. Various banks will use eligible securities as collateral through a repo agreement and will use the funds to alleviate their short-term requirements, thus remaining stable.

Fixed Rate Mortgage

Fixed Rate Mortgage

· A fixed rate mortgage (FRM) is a mortgage loan where the interest rate on the promissory note remains the same through the term of the loan.
· The term of the home mortgage can be 10, 15, 20 or the popular 30 year fixed rate mortgage term
· The benefit of a fixed-rate mortgage is that the homeowner will not have to contend with varying loan payment amounts that fluctuate with interest rate movements.
· The main disadvantage in fixed-rate mortgage is , Interest rate stays the same even if interest rates go down .
· For example, for a home loan of $150,000 with a fixed yearly nominal interest rate of 6.5% for 30 years, the principal is $150,000, the monthly interest rate is 6.5 %, the mortgage monthly payment is $948.10. If the mortgage interest rate is 8.50%, the mortgage monthly payment would amount to $1,153.37. The difference in monthly payments is $205.27.

BASE RATE

Term

BASE RATE

Meaning :

Base rate would be the new benchmark of pricing of loan products by the banks in India. Base rate would be coming into effect from 1st July 2010. The main idea behind implementing base rate is to incorporate more transparency in the lending mechanism of banks. Responding to the widespread feeling that banks do not set their lending rates in a scientific and transparent manner, the Reserve Bank of India has come up with Base Rate system.

The proposed system will replace the existing system of benchmark prime lending rates (BPLR) with base rates. The formula for calculating the base rate will take into account the cost of deposits, cost of complying with CRR and SLR requirements, and the need to retain a profit margin. Plus there will be a markup depending on the cost of operation for a particular type of product and premiums for credit risk and tenor of loans.

If you are a home loan borrower, the rate you see will be a sum of two costs: a base rate plus borrower-specific charges. A bank faces several costs. The first, called base rate, is common across all borrowers and will be made up of the cost of deposits (or what it costs the bank in interest payments to keep your money as deposits), the money notionally lost by the bank in statutory obligations that throw off no interest, general overhead costs and profit margin. Add to this the specific cost due to the product you buy, its tenor (length) and your own credit risk.
Product-specific costs mean that an unsecured loan would have a higher cost attached to it compared with a home loan, which has the house as the collateral.
Your credit rating with Credit Information Bureau (India) Ltd (Cibil) will now come into play and people with good credit scores will see the charges related to their own risk come down, meaning lower rates. Tenure-related cost would mean that the longer the loan is held, the higher the cost.
Analysts say the base rate for even the best banks would be in the region of 9%. With the cost of deposits at around 6% and adding around 0.75% to compensate for the lower yields on statutory holdings of government bonds and zero yield on cash reserves, an additional 1.25% to unallocable overheads and an average of 1% return on assets, the base rate would add up in this illustrative case to 9%.

Why BPLR didn’t work?
For years, home loan borrowers on floating rates felt cheated by banks as they paid more when interest rates rose, but did not pay less when they fell. Banks kept rates high for old customers and reduced them for new ones by keeping the benchmark prime lending rate (BPLR) sticky.
Not only did banks set BPLR in a non-transparent manner, they had several BPLR rates, each for a different category of loans—corporate and retail to name two.
To deal with this problem, among others, the Reserve Bank of India (RBI) announced the move from a BPLR model to a base rate system. The new rate will apply to all fresh loans but old loans, when they come up for renewal, can switch.

MUMBAI INTERBANK OFFERED RATE - MIBOR

MUMBAI INTERBANK OFFERED RATE - MIBOR

Meaning

The interest rate at which banks can borrow funds, in marketable size, from other banks in the Indian interbank market. The Mumbai Interbank Offered Rate (MIBOR) is calculated everyday by the National Stock Exchange of India (NSEIL) as a weighted average of lending rates of a group of banks, on funds lent to first-class borrowers.

The MIBOR was launched on June 15, 1998 by the Committee for the Development of the Debt Market, as an overnight rate. The NSEIL launched the 14-day MIBOR on November 10, 1998, and the one month and three month MIBORs on December 1, 1998. Since the launch, MIBOR rates have been used as benchmark rates for the majority of money market deals made in India.

Forces Behind Interest Rates

What is an interest rate?

An interest rate is the cost of borrowing money. Or, on the other side of the coin, it is the compensation for the service and risk of lending money. Without it, people would not be willing to lend or even save their cash, both of which require a deferment of the opportunity to give up spending in the present. But prevailing interest rates are always changing and different types of loans will offer various interest rates. If you are a lender, a borrower or both, it's important you understand the reasons for these changes and differences.

Lenders and Borrowers
The lender of money is taking a risk that the borrower may not payback the loan. Thus, interest provides also a certain compensation for bearing risk. Coupled with the risk of default is the risk of inflation. When you lend money now, the prices of goods and services may go up by the time you are paid back your money, whose original purchasing power would have decreased. Thus, interest protects against future rises in inflation. A lender such as a bank uses the interest to process account costs as well. The borrowers pay interest because they must pay a price for gaining the ability to spend now as opposed to having to wait years and years to save up enough money. For example, a person or family may take out a mortgage for a house for which they cannot presently pay in full, but the loan allows them to become homeowners now instead of far into the future. Businesses also borrow for future profit. They may borrow now to buy equipment so they can begin earning those revenues today. Banks also borrow in order to increase their activities, whether lending or investing, and pay interest to clients for this service. Interest can thus be considered a cost for one entity and income for another. Interest is the opportunity cost of keeping your money as cash under your mattress as opposed to lending. If you borrow money, then the interest you have to pay is less than the cost of forgoing the opportunity to have the money in the present.

How Interest Rates are Determined

Supply and Demand
Interest rate levels are a factor of the supply and demand of credit: an increase in the demand for credit will raise interest rates, while a decrease in the demand for credit will decrease them. Conversely, an increase in the supply of credit will reduce interest rates while a decrease in the supply of credit will increase them.The supply of credit is increased by an increase in the amount of money made available to borrowers. For example, when you open a bank account, you are actually lending money to the bank. Depending on the kind of account you open (a certificate of deposit will render a higher interest rate than a checking account, with which you have the ability to access the funds at anytime), the bank can use that money for its business and investment activities. In other words the bank can lend out that money to other customers. The more banks can lend, the more credit there is available to the economy. And as the supply of credit increases, the price of borrowing (interest) decreases. Credit available to the economy is decreased as lenders decide to defer the re-payment of their loans. For instance, when you decide to postpone paying this month's credit card bill until next month or even later, you are not only increasing the amount of interest you will have to pay, but also decreasing the amount of credit available in the market. This in turn will increase the interest rates in the economy.

Inflation
Inflation will also affect interest rate levels. The higher the rate of inflation, the more interest rates are likely to rise. This occurs because lenders will demand higher interest rates as compensation for the decrease in the purchasing power of the money they will be repaid in the future. Government
The government has a say in how interest rates are affected. The U.S. Federal Reserve (the Fed) often comes with out announcements about how monetary policy will affect interest rates.The federal funds rate, or the rate that institutions charge each other for extremely short-term loans, affects the interest rate that banks set on the money they lend; the rate then eventually trickles down into other short-term lending rates. The Fed influences these rates by the use of "open market transactions", which is basically the buying or selling of previously issued U.S. securities. When the government buys more securities, banks are injected with more money than they can use for lending, and the interest rates then decrease. When the government sells securities, money from the banks is drained for the transaction, rendering less funds at the banks' disposal for lending, forcing a rise in interest rates.

Types of Loans
Of the factors detailed above, supply and demand are, as we implied earlier, the primary forces behind interest rate levels. The interest rate on each different type of loan, however, depends on the credit risk, time, tax considerations (particularly in the U.S.) and convertibility of the particular loan. Risk refers to the likelihood of the loan being repaid. The bigger the chance of the loan not being repaid will lead to higher interest rate levels. If, however, the loan is "secured", meaning there is some sort of collateral that the lender will acquire in case the loan is not paid back (i.e. such as a car or a house), the rate of interest will probably be lower. This is because the risk factor is accounted for by the collateral.For government-issued debt securities, there is of course very little risk because the borrower is the government. For this reason and because the interest is tax-free, the rate on treasury securities tends to be relatively low.Time is also a factor of risk. Long-term loans have a greater chance of not being repaid because there is more time for adversity that leads to default. Also, the face value of a long-term loan, compared to that of a short-term loan, is more vulnerable to the effects of inflation. Therefore, the longer the borrower has to repay the loan, the more interest the lender should receive. Finally, some loans that can be converted back into money quickly will lose little if any loss on the principal loaned out. These loans usually carry relatively lower interest rates.ConclusionAs interest rates are a major factor of the income you can earn by lending money, of bond pricing, and of the amount you will have to pay to borrow money, it is important you understand how prevailing interest rates change: primarily by the forces of supply and demand, which are also affected by inflation and monetary policy. Of course, when you are deciding on investing in a debt security, it is important you understand how its characteristics determine what kind of interest rate you can receive.

Pay - Option ARM

Pay - Option ARM

· Pay Option ARM is an Adjustable Rate Mortgage that has multiple payment plans from which the borrower may choose. Each of the options are very different and factors such as time and interest rate must be carefully considered when choosing the plan.
· Pay Option Arm payment Options are:
o Minimum Payment Option(which may be less than the amount of interest due that month and may not pay down any principal).
o Interest-Only Payment Option(which does not change the amount you owe on your mortgage).
o 15/30/40 Year Fully Amortized Payment Option (payment of both principal and interest and keep the loan on schedule for a 15/30/40 year period).
· The interest rate on a payment-option ARM is typically very low for the first few months. After that, the interest rate usually rises to a rate closer to that of other mortgage loans. Your payments during the first year are based on the initial low rate.
· When a borrower makes a Pay-Option ARM payment that is less than the accruing interest, that leads to "negative amortization"(means the unpaid portion of the accruing interest is added to the outstanding principal balance).
· Pay Option ARMs are best suited to sophisticated borrowers with growing incomes, particularly if their incomes fluctuate seasonally and they need the payment flexibility that such an ARM may provide. Sophisticated borrowers will carefully manage the level of negative amortization that they allow to accrue.
· Option ARM loans are available with an initial introductory period, usually of 1, 3 or 6 months, after which the interest rate may change.
· Pay Option ARM also called "pick-a-payment" or "option" ARMs.
· Pay Option ARM loans are available with an initial introductory period, usually of 1, 3 or 6 months, after which the interest rate may change.
o With 1-month option ARMs that have a 1-month introductory period, the first interest rate change occurs when the 1st monthly payment is due. Thereafter, the interest rate may change monthly.
o If you have a 1-month option ARM loan with a 3-month introductory period, the first interest rate change occurs when the 3rd monthly payment is due. Subsequent interest rate changes may occur each month thereafter.
· Advantages:
o The low initial payment entices some borrowers into buying more costly houses.
o Borrower can minimize monthly payment to pay off other debt
o Sophisticated borrowers can take advantage of future increases in income
o Borrower can offset income fluctuations.
· Disadvantage:
o A sudden and sharp increase in the payment.
o The negative amortization can result in serious payment shock.
o The loan balance cannot exceed a negative amortization maximum, which can range from 110% to 125% of the original loan balance.
· Example: Loan Amount is $200000, Initial Rate is 1.25%, Index is 0.463%, Margin is 2.75%, Fully Indexed Rate ( index + margin ) is 3.213% then
o Minimum Payment: $666.50
o Interest Only Payment: $535.50
o Fully Amortizing 30-Year Payment: $866.36
o Fully Amortizing 15-Year Payment: $1,401.74
o Fully Amortizing 40-Year Payment: $740.74

Swap

Swap

An exchange of streams of payments over time according to specified terms. The most common type is an interest rate swap, in which one party agrees to pay a fixed interest rate in return for receiving a adjustable rate from another party.

CREDIT DEFAULT SWAP

Term

CREDIT DEFAULT SWAP (CDS)

Meaning

A swap designed to transfer the credit exposure of fixed income products between parties.

The buyer of a credit swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the product. By doing this, the risk of default is transferred from the holder of the fixed income security to the seller of the swap. For example, the buyer of a credit swap will be entitled to the par value of the bond by the seller of the swap, should the bond default in its coupon payments.

The Basics of Single-Name Credit Default Swaps

To understand the credit event auction default process, it is helpful to have a general understanding of single-name credit default swaps. A single-name CDS is a derivative in which the underlying instrument is a reference obligation, or a bond of a particular issuer or reference entity. Credit default swaps have two sides to the trade: a buyer of protection and a seller of protection. The buyer of protection is insuring against the loss of principal in case of default by the bond issuer. Therefore, credit default swaps are structured so that if the reference entity experiences a credit event, the buyer of protection receives payment from the seller of protection.

Credit Event

In the CDS world, a credit event is a trigger that causes the buyer of protection to terminate and settle the contract. Credit events are agreed upon at the time the trade is entered into and are part of the contract. The majority of single-name CDSs are traded with the following credit events as triggers: reference entity bankruptcy, failure to pay, obligation acceleration, repudiation and moratorium.

Hybrid ARM

Hybrid ARM

Meaning:
· In Hybrid ARM the interest rate remains unchanged for a certain number of years, and thereafter it starts to rise in step with the market interest rate up to a limit (rate cap) set in the mortgage agreement. Often the interest rate in a hybrid ARM is substantially lower than in the other types because the interest rate risk is shared between the lender and the borrower. It is considered more suitable for those who plan to sell their house between five to seven years.
· Hybrid ARM blends the characteristics of a fixed-rate mortgage and an adjustable-rate mortgage. This type of mortgage will have an initial fixed interest rate period followed by an adjustable rate period. After the fixed interest rate period expires, the interest rate starts to adjust based on an index(This is the market derived interest rate which is used as a base to set future rates of the ARM mortgage loan) plus a margin. The date at which the mortgage changes from the fixed rate to the adjustable rate is referred to as the reset date.
· Hybrid ARMs feature a fixed interest rate for a period of years -- commonly 3, 5, 7 or 10 years -- before they turn into a traditional one-year ARM for the remainder of a 30-year term.
· Most Hybrid ARMs have an additional layer of interest-rate limiter, called the "first adjustment cap", which applies only after the fixed-rate period of the Hybrid comes to an end. Thereafter, typical "periodic" caps will apply. However, that first adjustment cap may provide little or virtually no protection against a hostile rate environment.
· A hybrid ARM is ideal for individuals who plan to sell their homes within 7 to 10 years, because they can benefit from the low initial payments and dump the loan before its higher period begins.
· It is also known as Fixed Period ARMs or Delayed First-Adjustment ARMs
· Advantage
In Initial fixed period borrower can enjoy the less interest rate which is less than the interest rate with a fixed-rate loan .
· Disadvantage
The interest rate can increase over time and cause a mortgage payment to go up.
· Example:
On a loan of $300,000. Let’s say the current mortgage is fixed at 5.8%, which means the monthly payments are about $1760. If borrower refinanced into a 5-year hybrid ARM with an initial fixed rate of 5.05%, the mortgage payments would be reduced by about $140 per month. at the end of 5 years hybrid ARM, saving will be $8,400 over fixed mortgage with 5.8 interest rate!

Gross Domestic Product - GDP

Term

Gross Domestic Product - GDP

Meaning

The monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory. GDP = C + G + I + NXwhere:"C" is equal to all private consumption, or consumer spending, in a nation's economy"G" is the sum of government spending"I" is the sum of all the country's businesses spending on capital"NX" is the nation's total net exports, calculated as total exports minus total imports. (NX = Exports - Imports)

GDP is commonly used as an indicator of the economic health of a country, as well as to gauge a country's standard of living. Critics of using GDP as an economic measure say the statistic does not take into account the underground economy - transactions that, for whatever reason, are not reported to the government. Others say that GDP is not intended to gauge material well-being, but serves as a measure of a nation's productivity, which is unrelated.
Following is the 2009 GDP List by the International Monetary Fund