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| *Ostroff, Fair and Company>>>Financial Services |
What are "Credit and Interest Rate Instruments"? |
I am applying for a position where one of the requirements is: - Understanding of Credit and Interest Rate Instruments. I have searched for that term but cam up empty-handed. What are some examples of Credit and Interest Rate Instruments? Thanks They are referring to bonds (loans) and related derivatives. In this context credit instruments will be bonds issued by companies. These are fixed income securities that normally pay a set amount each month (the coupon) and then after a certain amount of time it will repay the principle (the amount that was borrowed). The yield is the percentage of the price that is the coupon. These bonds are traded on the financial credit markets and so their price is determined by the supply and demand in the market. Say a 拢100 bond pays a 拢5 coupon, so the yield will be 5%. Now say the interest rate rises to 10%. In order to give a competitive yield the bond price will have to drop to 拢50 so that its 拢5 coupon payment represents a 10% yield. The present value of the principle repayment will also decrease as you have to discount the future more. 拢100 in a year's time is worth less than 拢100 now as I could earn a year's worth of interest on the cash I have now. Bonds issued by companies will also be assessed for default risk, that is the chance the company will run into trouble and miss a payment. Ratings companies like Moody's and S&P issue ratings that measure the riskiness of the bond. For example S&P gives a rating of AAA for the most credit worthy bonds (little chance of default). Bonds with a rating below BBB- are termed high yield or "junk" bonds. They give higher yields but are much more risky.Companies with credit ratings above BBB- have bonds that are termed investment grade. For example the British insurance company Legal & General has a credit rating of AAA, but the struggling car maker Ford had a rating last year of BB-, making their credit issues junk bonds (they are 3 ranks below BBB-) Interest instruments in this context refers to bonds issued by governments. In the US they are known as Treasury bills and in those issued by the Bank of England are known as gilt edged securities. They are seen as safe investments with risk below even AAA rated companies. Most government bonds work in the same way as company bonds. One exception is the British consul. This is also known as a zero coupon bond as it pays nothing monthly but instead pays any interest when the bond expires along with the principal. These plain credit and interest rate instruments also give rise to more complex instruments known as derivatives. Derivatives derive their value from another financial instrument. Examples include swaps, futures, options. A swap is a contract that essentially means you sell one bond and then buy another. Futures are contracts that mean you buy a bond for a certain price at a certain time in the future. Obviously you make a profit if it turns out that the bond in the future is worth more than the price you pay for it using your future contract. Options are like futures, but they give you the right to buy at the specified condition and not the obligation. You do not have to exercise an option if at the time of its expiration it is not in the money. These derivatives are themselves traded on financial markets. New credit and interest rate instruments are created by securitisation. This s in the news a lot at the moment because of the sub-prime crisis. If a mortgage company or bank has a lot of mortgages on its books it is limited with the use of its capital as it needs to keep money to pay out to the people taking out loans. What these banks do is sell the mortgages to an investment bank that securitises them. It collects a bundle of mortgages, loans and other assets together and packages the as single security that can be traded like a bond. The coupon payments are effectively the mortgage payments. It's actually a bit more complex than this. These credit instruments known as Collaterised Debt Obligations (CDO) or Collaterised Mortgage Obligation (CMO) are structured into different tranches, with different tranches having different interest rates and risk levels. The sub-prime crisis spread so widely because many high risk mortgages in America were packaged into CDO that were sold all over the world to many investors. Now that many US home owners have defaulted on their loans the value of the CDOs were affected and this had knock on effects because so many investors have had returns less than they were expecting or indeed relying on. Source(s): Some good places to research: http://en.wikipedia.org/wiki/fixed_incom... http://en.wikipedia.org/wiki/bond_market... http://en.wikipedia.org/wiki/corporate_b... http://en.wikipedia.org/wiki/government_... http://www.investopedia.com/articles/03/... go to wikipedia and type the things there u can get a lot more information than u get in here zxc Are you applying for a processor or Loan Officer position? That's what is sounds like. You might need to do some homework prior to the interview about how to read credit report, what to identify in them etc...for example there are fraud alerts, hawk alerts, open accounts with huge balances, late payments showing up, too many credit cards open, etc...look online and start researching how to read a credit report. Interest Rate Inst. is probably a document or some type of method that they use to determine what the rate is for a specific loan program or product. I would think? But could be wrong. I would also think that this is done differently at every bank, but the concepts may be similar. Again, look this up and do your homework, prior to interview. Good luck, mortgage industry is struggling right now, but it's a good place to get your foot in the door, and can lead to good opportunities. Work at a bank |
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