Orange County Register

This week in his blog, Mortgage broker Dennis C. Smith of Stratis Financial in Huntington Beach offers what he calls a simplified version of “Bonds/Mortgages 101”.. An excerpt:

Q.:  Can you give me a refresher on the mortgage market and why ‘up’ is good?
 
A.:  ”Mortgages are backed by Mortgage Backed Securities (MBS), which are essentially bonds and trade as bonds and compete with other bonds for investment dollars. 
 
If a lot of investors feel the price of an investment will go up then they will all bid for the investment and create high demand. High demand raises prices. If a lot of investors feel an investment will decline in value then they will all put their investment up for sale and create high supply. High supply lowers prices.
  
Mortgage Backed Securities have a yield, a return on the investment, that is an interest rate. If you have a 30 year mortgage at 5%, when you pay the 5% interest payment that becomes a 5% rate of return for someone’s investment. 
 
Now comes a bit of math that has given some people problems … Bonds and MBS have a price, a face value and a stated yield.  A U.S. Treasury bond has a face value of $100.00 and pays 5% per year; if you hold the bond the U.S. Treasury will send you $5 every year. What if you can get 6% at your local bank? Why pay $100 to get $5 back when you can get $6, 20% more, from your bank? You would not, so instead of paying $100 for that bond you would offer someone $83 so the $5 annual interest payment is a 6% return. You pay a lower price to get a higher return: price is down, interest rate is up.

 
Suppose it went the other way? Suppose the local bank is paying 4% interest? No one will sell you a $100 bond paying a 5% return, they would be losing money. So to be competitive with the 4% return the bond will sell for $125, now the $5 annual interest payment is only 4% of the price of the bond. You pay a higher price to get a lower return:  price is up, interest rate is down.
 
Simplified: A playground teeter-totter … as price goes up rate goes down.  As price goes down, rate goes up.
 
Predicting the future of the investment is the tricky part, and why some guys on Wall Street have collected hundreds of millions in bonuses; if you are dealing with a $100 million portfolio one-tenth of one percent (0.001) is $100,000; now juggle several such portfolios at one time.  That decimal point on $1 billion is $1 million.  Predict correctly and move that decimal point higher and you profit handsomely, incorrectly and the decimal point drops and you lost money on your investment.
 
In predicting bonds and MBS there are few lone rangers.  The simple version is if there is good economic news today, or probably tomorrow, then bond and MBS price will go down — and rates up.  If there is bad economic news today, or probably tomorrow, then prices will go up — and rates down. 
 
If you wake up and the paper says unemployment went down and consumer spending went up, expect rates to be up.  If you wake up and unemployment is higher and consumer spending is down, expect rates to be down.”

From the weekend — Did you miss:

• A TV in the ceiling? What ‘Cougar Town’ didn’t show
• What did 25 Surf City houses just sell for?

.

Latest on mortgages:

You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.