MBS - P/L calc

Hello,

Like many things in life, fixed income puzzles me beyond my lackluster imagination. Just don’t know how it works. So here it is.

I buy a bond specifically an MBS, 144531EF3. Here is the buy details.

Factor: 1

Coupon: .628%

Price: 77

Quantity: 1 mm

SD: 1/24/14

Net Money: 770,505.89 with 29 days of accrued interest

This bond pays interest monthly every 25th day.

let’s say next month the coupon stays same but the factor went down to .9. Now I get paydown amount (iincoming) and an interest amount (using new factor and same coupon rate). Then I sell this bond for 80.

Now how is the whole paydown and interest come into play into my realized gains and how does one price this bond. How can a bond go from 77 to 80 in 30 days. I thought bond prices theoretically move towards par but this is such a big jump? Supply and demand?

Thank you in advance.

From an accounting standpoint, the paydown would reduce your carrying value, so when you sell it you would have a gain based on the new (lower) carrying value; the interest would be shown as income.

From a tax standpoint, I don’t know whether they treat the paydown as a return of investment (nontaxable) or as income; I’d hope for the former, but that may not be the case.

As to why the price would jump from 77 to 80, there are many factors that could contribute to that:

  • General level of interest rates declining
  • General lowering of credit spreads
  • Lowering of the specific credit spread for that bond
  • General supply and demand

the carrying value as in book value? So the original cost remains on the books as the factor * price/100 * quantitiy. but the book value is using the new factor? also if the interest received is shown as income, does the accrued interest on the initial buy trade go straight to the IS as well? I would not use the net money (including the accrued interest on the buy) as my original cost rihgt?

Yes.

There’s no reason to retain the original cost on the balance sheet. If you bought the MBS at a premium or a discount, you’d likely record the asset at par value and the premium or discount separately (and then amortize that premium or discount over the remaining life of the MBS), and as you receive principle payments, you would reduce the asset value by those amounts.

I should think so; it wouldn’t make sense to do anything else.

Correct.

thanks a lot Magician. !!

For the second point:

As an investment mgmt firm we would show the MV (Whatever we bought at. For subsequent months like you stated it would show the current book value) in the balance sheet and would not have a separate account.

My pleasure.