MORTGAGE BACKED SECURITIES (MBS) Part 1 "The Bundle"
Recently I posted an article on how Credit Defaults Swaps worked and promised to do one on Collateralised Debt Obligations (CDOs).
Before I explain how CDOs work, I thought it would be easy to go to the beginning and look how Mortgage Backed Securities (MBS) are formed and how these are then fed into CDOs.
In order to make the explanation easy I have made the numbers very simple purely to help illustrate with ease the way they are formed.
Let say a person takes out a Mortgage Loan on a Property for $1M over a 10 Year period based on a fixed rate of 10%/year. For ease let’s say the Loan was taken out on Interest Only payable each year.
The repayments of the loan would be $100k/year x 10yrs + $1M.
A Mortgage Backed Security starts its life off by first bundling a number of Mortgages together.
Let’s say the Bank bundles 1,000 similar mortgage loans together into a Bundled Package with each loan being $1M at 10%, for 10 years.
This will be 1,000 x $1M = $1B, 10 Years, 10%/years.
The repayments of the Bundled Loan would be $100M/year x 10yrs.
So now instead of 1 mortgage the Bank now has a Packaged Bundle of 1,000 mortgages each contributing to a Yearly Income of $100M.
This is the first step to a Mortgage Back Security (MBS).
In Part 2 I will explain how the Packaged Bundle is then converted into a Mortgage Backed Security (MBS) ready for trading..!!
Thanks for reading and please feel free to share.
Stephen