Interest-only strip

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Related to Interest-only strip: IO Strips

Interest-only strip (IO)

A security based solely on the interest payments from a pool of mortgages, Treasury bonds, or other bonds. Once the principal on the mortgages or bonds has been repaid, interest payments stop, and the value of the IO falls to zero.
Copyright © 2012, Campbell R. Harvey. All Rights Reserved.

Interest Only Strip

A derivative security whose cash flow derives exclusively from interest payments on various debt securities. That is, the underlying asset of an interest-only strip is interest paid on debt securities, rather than the debt securities themselves. Many interest only strips are backed by mortgage interest, but some are also backed by Treasury securities and other debt securities. Interest-only strips are derived from bonds whose coupons are legally separated, or "stripped", from the bonds themselves.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved
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Allocation of Carrying Amount Based on Relative Fair Values: Fair Value Percentage Allocated of Total Carrying Fair Value Amount Loans sold $1,040 94.55% $945.5 Interest-only $ 60 5.45% $ 54.5 strip receivable Total $1,100 100% $1,000 (Interpretive note: The carrying amount of the loans ($1,000) is allocated to loans sold and the interest-only strip receivable, which is another asset created in this transaction and not sold.
Total (Credit) Enhancements: Sum of interest-only strips, subordinated securities, and other residual interest; standby letters of credit; and other enhancements divided by total loans in the category.
Previously recognized servicing receivables that exceed contractually specified servicing fees should be reclassified as interest-only strips receivable.
The final rule also imposes a "dollar-for-dollar" capital charge on residual interests and a concentration limit on credit-enhancing interest-only strips, a subset of residual interests.
The guidance addresses risk-based capital treatment pertaining to (1) split or partially rated instruments, (2) nonqualification of corporate bonds or other securities for the ratings-based approach, (3) spread accounts that function as credit-enhancing interest-only strips, (4) audits of internal credit-risk rating systems, and (5) cleanup calls.
New standards are added for the treatment of residual interests, including a concentration limit for credit-enhancing interest-only strips. Credit ratings from rating agencies and certain limited alternative credit-rating approaches can be used by banks to match the risk-based capital requirement more closely to their relative risk of loss for certain positions in asset securitizations.
Innovative financial instruments and transactions--such as interest rate swaps and caps, foreign currency options, interest-only strips, asset securitizations and many more--have become commonplace and are changing the role of traditional instruments such as loans, bonds and stocks.