Assignment of Trade (AOT)
In general, the term "assignment of trade" refers to a process where someone in a forward contract (meaning a deal that is set to take place at some point in a future) makes a separate side deal with to assign their part of the agreement to a third party. Remember the game of telephone as a kid? You know, the one where you whisper something to the person next to you and they repeat what they heard to the person next to them and on down the line until "I like your shoes" becomes "Eye lines in York are a snooze."
Assignment of trade is basically the transactional equivalent of telephone (only hopefully nothing gets degraded along the way - you're just passing the deal along to the next person).
The term has its most notable relevance in the market for mortgage-backed securities. An MBS is a tradable asset similar to bonds that derive their income from revenue from home loans. Some mortgage-backed securities are traded on what is called the "to be announced," or TBA, market. This sounds like something a bad business school student would make up after forgetting to do their homework, but it's a real thing in the MBS world.
Individual mortgages differ in a lot of ways. The size or quality of the home, the location, the credit histories of the people who own the house, etc. In the TBA market, companies take pains to make sure the mortgages are as similar as possible, to the extent that they are virtually interchangeable.
Because of this, the exact nature of a particular mortgage becomes irrelevant - any particular mortgage within a certain type is as good as another. Thus, companies trade in the market without having to know specifics of the mortgage pool they are trading - the details are literally TBA.
In this context, companies are able to move pretty fast and can use the assignment of trade technique. By making a deal and immediately assigning the assets to a third party, a company seeks to fine-tune the timing of the transaction. This way, the firm can maximize its return while minimizing its risk. When using this strategy, the company at the center of the trade doesn't want to hold the MBS for any length of time. Instead, it creates a situation where it moves the securities onto a third party, lowering its risk and optimizing its return.
Related or Semi-related Video
Finance: What is the Process of a Bank L...107 Views
finance a la shmoop. what is the process of a bank loaning money ? alright well
there are two key factors a bank focuses on to determine the likelihood and terms
in your getting dough from them. alright one can you afford to pay the loan back? [ man in office speaks to camera]
like what do you do for a living? how much do you make? is it likely you'll
still be employed after the next economic downturn? you know stuff like
that and then there's two. if you don't pay back the loan you promise to pay
back then which of your assets can they take from you, so that they get their
money into the interest you were supposed to pay back .okay example time [Man carries money in front of a for sale sign]
you're buying a house first one. you scrimped you save and now you think you
can afford this half-million dollar home in palo alto. and that's what half a
million bucks buys you here. well you have 50 grand in savings ready to put
down on the house, and you have a nice job as a personal trainer to the stars [man smiling in a gym]
of Silicon Valley, they look a little different from the stars of Hollywood. so
yeah you'll never be out of work. you make about 70 grand a year but it's all
as an individual contractor, so you have great periods of time where you make
bank and then months where you make a whole lot of nothing. well after taxes on
average your seventy K is about 50 K which is all you've got to your name. you [math equation]
thought you'd put 10% down, but didn't realize that you'd have to pay real
estate taxes in advance, and then other closing costs so you really needed
$60,000 but the bank wants your business
mainly because, well, their biggest [businessman talks to man in gym]
customers are your clients. prevailing interest rates on mortgages are 6% but
you're not exactly a Bill Gates credit risk, so your cost of interest will be
higher. they quote you an 8% mortgage rate if you put 20% down on the house.
but you don't have 20% to put down. you have way less, which means more risk to
the bank,and lending you the money meaning it's higher risk that they don't [equations shown]
get paid back, so they'll charge you more for renting the money from them. so the
price they charge you is 10% interest to rent the money because well you have to
pay for insurance, or PMI. that covers you if you don't pay them back. and yes that
sounds harsh and cruel, but well welcome to the real world. so you're
thinking that you have a loan of 460,000 dollars that extra 10 grand covers
closing costs and taxes and other things like maybe a little furniture a place to
sleep on. on 10 percent interest you'll pay 46 thousand dollars a year just in [equations]
interest. well essentially all of that interest is directly tax-deductible so
instead of your seventy thousand dollars being fifty thousand after taxes, as far
as the IRS is concerned ,you no longer make seventy thousand dollars you make
seventy thousand dollars minus forty six thousand dollars, or just twenty four
grand a year ,and your taxes on that are like that two grand maybe even a little
less .you almost qualify for food stamps. and that's good you might need them, [man chews on food stamps]
because two grand will just barely pay for the food you'll need to, you know
live. so the bank just barely passes you to qualify for this loan after checking
to be sure that you know you've never had a missed payment on a credit card, or
any other loan, or had any other issues like a DUI or some criminal thing that
would give any lender a cause to pause. so the above is all about your ability [checklist shown]
to pay that was number one. right number two what comes next is all about the
risk to the bank. you bought a home in a very active real estate market. the bank
presumes that they can always sell the home but the home is doubled in value in
the last three years, and the bank knows that this rate of appreciation is not
normal. so there's a lot of risk if the home drops in volume 30 40 maybe even 50
percent in the short run so there is a scenario where the home you just bought
for five hundred grand ends up selling for 300 grand less 20 [boxes and for sale sign]
grand in commissions and costs and that's only 280 G's. well the bank loaned
you four hundred sixty thousand dollars and in this scenario you'd of course
lose the fifty thousand dollars you put down at your down payment, but the bank
would then lose a hundred eighty thousand dollars as well. and you know
banks don't like to lose money. at least the ones that do don't stay in business
very long. yeah. so that's the process pay your loans. [ group smiles in front of Christmas tree]
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