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Copyright © 2012, Campbell R. Harvey. All Rights Reserved.

Principal Only

Describing a derivative in which the underlying assets are the future principal payments on a pool of mortgages or other debt obligations. Principal-only derivatives are issued at a deep discount to their par value; that is, one buys such derivatives for an amount less than the principal payments to which the holder is entitled. The gain on a principal-only derivative comes from the amount by which principal payments exceed the amount that the holder pays for the security. For that reason, holders of these derivatives can benefit from prepayment risk because when property owners repay their mortgages more quickly, principal-only derivative holders receive their returns more quickly.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved

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Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved. All rights reserved.