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Yields in Government National Mortgage Association
Yields in GNMA securities are also difficult to determine precisely. If you are not sure of the size, frequency and regularity of the cash flow, you should determine the exact yield of the investment. However, varied methods have been developed to calculate those yields. They are based in different suppositions over the fastness of prepayments (fast, average or slow).
On an offering sheet a number of yields are quoted depending on the FHA-estimated experience of prepayment speed. The slowest speed offers the highest yield. Then, from a safe point of view, when you purchase GNMA securities, have the following in mind:
- Risks of reinvestment are greater for GNMA securities than for other fixed-income securities because interests and returns of principal payments are done monthly for the pass-through securities, instead of semi-annually or annually as for regular bonds. For example, if a significant change occurs with market interest rates, the return of interests and principal are reinvested at lower rates, and the overall returns is lower for the GNMA investments that are quoted yield-to-maturity, assuming reinvestment at the quoted yield.
- Exact return rates cannot be determined because of uncertainty of the existing risk when reinvesting
- If monthly interest payments and of principal are spent instead of being reinvested, the overall return rate is even lower
- Prepayments of principal should not be included in yield of cash flow because it is the investors return of the initial investment
The GNMA securities and all the pass-through securities, as well as all the other fixed-income securities are sensitive to changes in rates of interests in the market. When the market raises the rates of interests, bond prices fall. When the market’s rate of interests decline, many house owners prepay their mortgages and then refinance with mortgages at lower rates.
This process works as a ceiling over GNMA prices, that way they won’t be increased that much, as prices of bonds do when market rates decline. You not only receive principal before, but confront reinvestment of yield in your investments with lower yields.
You may purchase GNMA securities directly from the issuer through dealers and brokers. The minimum amount of purchase is $25000. However, you may purchase GNMA mutual funds or unit investment trusts investing amounts as low as $1000 or $2500 ( the minimum amount specified by the GNMA mutual fund or investment trust).
You can buy or sell existing issues of GNMA securities in the secondary market. GNMA securities are so negotiable as liquids due to their great volume of negotiated issues.
When you purchase from a broker or a bank, you should take into account the following topics:
- Prices priced on the financial newspapers or offering sheets are oriented to large buyers (institutions), small investors are quoted larger spreads (difference between bid and ask prices).
- Yields that are quoted are based on prepayment assumptions. If only one yield is quoted, ask your broker for the different prepayment assumptions and their corresponding yields. Use the most conservative yield because even then it may not be realized.
- The remaining term of the mortgage pool or length of time until maturity is not as important as the weighed- average life because the former assumes no prepayments the assumption in the secondary market is that a 30-year GNMA will be repaid, on average, in 12 years.
- Prepayment is important. If GNMA are negotiated at premium you could be willing to suffer a loss of capital. If the interest rates decline, house owners could repay their mortgages in the pool before time. Then, you could not recover the premium that you paid over the face value, and also would have to reinvest your money at lower interest rates.
Buying at a discount gives you the opportunity to earn capital, but the coupon yield for GNMA is lower than the coupons offered in times like this.