YIELD SPREAD PREMIUM and CREDIT DEFAULT SWAPSIN SECURITIZED RESIDENTIAL MORTGAGE LOANSby Neil F. Garfield, Esq.ALL RIGHTS RESERVED
In discussing yield spread premiums we have to define the three different words contained in thatexpression.
is an amount which is derived from an investment. For example, if one invests$1,000.00 in the expectation of receiving 5 percent interest per year, the yield could be expressedas $50.00 per year or 5 percent. A yield spread does not exist unless there are two different loansand in the case of mortgage lending it would be two different loans, both of which the borrower qualifies for.So if we are looking at Loan No. 1 which is a 30-year loan and has a yield of 5 percent based ona principal of $1,000,000.00 then the person who buys a bond or lends the money would belending $1,000,000.00 in the expectation of receiving 5 percent or $50,000.00 per year. Theyield is either expressed as a percent or as a dollar expression. The future 30year loan value isthe principal that the investor or lender advanced which is $1,000,000.00 in our example plus allthe interest paid over the 30 years at the rate of $50,000.00 a year which would be$1,500,000.00. Therefore the future value of the loan without discounting it to present valuewould be $2,500,000.00. If such a loan were to have been approved and taken by the borrower you would have an APR annual percentage rate which is slightly higher than the yield because of the effect of amortization on a loan which is payable in monthly installments so the APR might be shown on the good faith estimate as perhaps 5.2 percent even though the stated interest rate is5 percent.
SIMPLIFIED EXAMPLE ISOLATING ONE LOAN OUT OF POOLED ASSETS
(THOUSANDS OF LOANS)Borrower qualifies for Loan #1 and all other loans in example
Loan #1Loan #001-30 yearsPrincipalAPRYieldPrincipal