Glossary of Finance and Economic Terms (G-M)
Please Note: All definitions used in this glossary were derived from the Freddie Mac Seller/Servicer Guide glossary. For specific information governing the use of material presented on this website, see our Terms & Conditions.
General Market Risk. See Market Risk.
Ginnie Mae. Federal government corporation that issues and guarantees securities backed by residential mortgages insured or guaranteed primarily by the Federal Housing Administration (FHA) and Department of Veterans Affairs (VA). Ginnie Mae, officially known as the Government National Mortgage Association, was created in 1968.
Gold Measure. Risk-management tool used to underwrite income-targeted mortgages. Adopting a scorecard approach to credit assessment, the tool weights the magnitude of default danger posed by individual risk elements and also recognizes compensating factors that can lower the relative default risk.
Government-Backed Mortgage. Residential loan insured or guaranteed by the federal government against borrower default through programs administered by the Federal Housing Administration (FHA), Department of Veterans Affairs (VA) or Rural Housing Service (RHS) programs.
Government-Sponsored Enterprise (GSE). Entity created by Congress that operates with private capital under a government-defined mission and charter. Housing-related GSEs include Freddie Mac and Fannie Mae.
Grace Period. In mortgage business vernacular, a time interval specified by the lender that begins the day after the official mortgage due date and typically runs for one or two weeks. When a borrower fails to make the scheduled payment by the conclusion of the grace period, a late fee is imposed.
Guarantee. With respect to mortgage-backed securities, a pledge to investors that the issuing company will bear the default risk on the collateral pool of loans, thereby ensuring the timely payment of principal and interest owed to investors.
Guarantee Fee. Compensation charged for undertaking responsibility for another’s debt. The original debtor still is liable for payment, but the guarantor must honor the obligation if the debtor defaults. Secondary-mortgage-market companies charge guarantee fees--typically about one-quarter of a percentage point of the loan amount--for bearing the default risk on loans pooled into securities.
Haircut. Difference between the market value of a security and the amount of money a lender will advance against it; the lender keeps the difference as insurance against a decline in the collateral value of the instrument.
Hedge. Process by which the risk of incurring a loss on a particular asset liability is reduced by entering into one or more financial transactions that are negatively correlated with the item’s value, thereby providing an offsetting gain when the item’s value drops.
HUD Code. Name by which the Federal Manufactured Home Construction and Safety Standards law is known because it is administered by the Department of Housing and Urban Development (HUD). The code, first drawn up in 1976, addresses design, construction techniques, strength and durability issues, fire resistance and energy efficiency.
Idiosyncratic Risk. Chance of loss due to factors specifically associated with a particular investment, such as Management or Operations Risk. It is unrelated to systemic economic movements or trends (Market Risk)
Initial-Adjustment Period. Interval of time from the origination of an adjustable-rate mortgage (ARM) to the first scheduled adjustment. Loan’s initial interest rate is locked in place for a designated time frame, for example, one, three, five or 10 years. At the end of that time, the rate adjusts to reflect prevailing market interest rates.
Interest-Rate Cap. Limit on the amount an interest rate may increase and/or decrease during an adjustment period or over the life of an adjustable-rate mortgage (ARM).
Interest-Rate Risk. Chance of loss due to fluctuations in interest rates that cause a value change in a mortgage or other fixed-income instrument. Generally, a rise in rates causes a decline in the price of an existing mortgage, while a decline in rates causes a rise in its market value.
Interest-Rate Swap. Arrangement wherein two parties agree to exchange interest payments based on a principal amount (referred to as the notional amount) without exchanging the underlying notional amount. Typically, one party pays a fixed interest rate and the counterparty pays a variable interest rate.
Internal Models. Method of determining a firm’s capital adequacy for regulatory purposes that relies on the technical evaluation by the regulated company of its own risks and capital needs. This approach was utilized for the first time in the recent Market-Risk Rule adopted by bank regulators.
International Swaps and Derivatives Association (ISDA). Principal trade organization for the privately negotiated derivatives industry. ISDA develops and publishes master agreements for swaps and other over-the-counter derivative contracts. ISDA agreements serve as standard industry documentation for a variety of financial instruments.
Inverse Floater. Derivative whose value changes inversely to the movement of interest rates, stock indexes and the like. Conversely, a floater operates in the same direction as the underlying trigger.
Joint-Probability Ellipse. Graphical representation of all the Joint-Probability-Distribution outcomes that are likely to occur a certain portion of the time, for example in 99 percent of the cases. Characteristically, the outcomes that lie on the ellipse boundary are all equally likely to occur. Points that fall along concentric elliptical rings within the ellipse boundary are increasingly likely to occur. Points occurring outside the ellipse boundary are lower-probability events, which, in the case of an ellipse drawn to a 99-percent probability, would happen 1 percent of the time.
Kitchen Sink Bonds. Relatively new but risky breed of bond structure that uses a combination of tranches (the various cash flows generated by the underlying instruments) from previous deals as collateral. Kitchen-sink instruments are sometimes created to camouflage highly risky bonds. The complex combination at the collateral level affects the entire bond. The behavior of even a simple bond backed by a combination of collateral may prove very erratic. The extra yield offered in the primary market does not usually justify the excess risk hidden in such deals.
Late-Fee Assessment Date. Point at which the grace period ends and the borrower must pay a late charge for failing to pay a regular installment payment when due. Generally, the fee is calculated as a percentage--typically in the range of 1 percent to 5 percent--of the monthly payment. For example, if a monthly payment is due on the first of the month, and a borrower is given a 15-day grace period, the late-fee assessment date would fall on the 16th of the month.
Leading Economic Indicators. Economic measure that combines a number of expectation-driven indicators--such as stock markets and consumer confidence--with indicators derived from real economic activity--such as manufacturers’ new orders and the length of the average work week. The index is calculated and published by the Conference Board, a nonprofit research organization.
Leverage Ratio. Measure of the extent to which a firm itself is financing an investment, rather than its creditors. The measure is expressed as total long-term debt divided by total shareholders’ equity. An immutable accounting relationship exists among a firm’s capital, debt (leverage) and assets, namely that capital plus debt equals assets. Thus, a firm’s debt-to-assets ratio provides the same information as its capital-to-assets ratio. Nowhere among these three factors is risk identified, except as implied by the quantity of assets; assets that could be either risk free or extremely risky.
Liability-to-Asset Ratio (LTA). Universal-account corollary to the traditional mortgage’s loan-to-value (LTV) ratio. Specifically, the ratio expresses all of an account holder’s liabilities, meaning debts, as a percentage of all financial and real property assets held in the account.
Liquidity Risk. Chance of loss due to a firm’s inability to quickly convert noncash assets into cash or to obtain cash to pay upcoming debts. Examples: a firm’s inability to ac-quire funds in the capital market on short notice and at low cost; its inability to rebalance or close out trading positions.
Loan Modification. Restructuring of a mortgage for a borrower who faces a long-term financial problem but can demonstrate the ability to meet the modified payment terms. The modification can include lowering the original interest rate or extending the loan term in which the borrower has to repay the entire amount of the loan.
Loan Officer. Employee at a loan company who works with individuals to identify and explain the various loan products available to mortgage borrowers. The loan officer typically conducts the initial review of the mortgage application.
Loan Prospector. Freddie Mac’s automated underwriting service that tells a lender within minutes whether Freddie Mac will purchase a particular mortgage. This determination reflects the likelihood that the loan applicant will default, based on an analysis of the loan application, credit and property information provided.
Loan-Loss Reserves. Funds reserved for losses a company anticipates it will incur from bad debts that occur with ordinary frequency, such as a predictable number of mortgage defaults. The account is replenished by periodic charges against earnings to protect against distributing all of the company’s Retained Earnings. The entry for reserves appears on the asset side of a bank’s balance sheet as a deduction from total loans.
Loan-to-Value Ratio (LTV). Amount of a mortgage loan expressed as a percentage of the collateral property’s value. This figure is related inversely to the down payment or equity in the property. For example, an LTV of 80 percent and a down payment of 20 percent refer to the same equity relationship. The ratio often is used in mortgage underwriting as a measure of default deterrent, based on how much equity a borrower personally stands to lose in the event of default.
London InterBank Offer Rate (LIBOR). Index used to benchmark floating-rate assets. It reflects the interest rate that the most creditworthy international banks dealing in Eurodollars would charge each other on large loans.
Loss Mitigation. Agreement reached by a lender and borrower to satisfy a delinquent mortgage obligation through a course of action that serves as an alternative to foreclosure. These efforts can range from simply bringing the delinquency to the borrower’s attention to working out an alternative repayment plan.
Manufactured Housing. Housing structures built in accordance with the HUD code. Unlike other forms of housing built to a state or local construction code, manufactured-housing units must have an integral chassis and must be transported on their own axles and wheels in one or more sections from the factory.
Marked-to-Market. Accounting valuation method based on the daily market prices of financial assets or commodities as opposed to their historical or acquisition values. A bank must use this method for its trading book, registering any losses or gains on a daily basis.
Market Risk. Chance of loss due to changes in interest rates, exchange rates, commodity prices or stock prices. Both the volatility of these market prices and the sensitivity of a firm’s portfolio value to these movements determine the company’s market-risk exposure.
Market-Risk Rule. U.S. bank regulatory rule which took effect January 1998 that bases a bank’s capital charge for its Trading-Book risks on calculations made by the firm’s own internal risk-analysis model. Rule applies only to banks with significant amounts of trading activity.
Mezzanine. In a multi-class security, the mid-range-risk tranche, typically split into several more credit layers of varying risk. This tranche bears less risk than the first-loss-position tranche but carries more risk than the senior-position tranche. Accordingly, the return to investors taking a mezzanine position will fall somewhere between the rates earned on investments in the first-position and senior tranches.
Micro-Data Set. Data collected at the individual unit of the set surveyed. For example, results might be recorded at the person, family, housing unit or loan level, whereas a macro-data set might focus on aggregate housing starts for a month.
Minimum Capital Standard. Capital-adequacy measure of the least amount of capital required by regulators of a financial institution to offset the firm’s risk of generating losses to the depository-insurance fund (or potentially to taxpayers). For Freddie Mac and Fannie Mae, this level is roughly equal to 2.5 percent of aggregate on-balance-sheet assets and 0.45 percent of the unpaid principal balance of outstanding mortgage-backed securities.
Mortgage Insurance. Insurance policy paid for by the borrower with the lender as beneficiary, in which a third party--the insurer--takes some of the loan-default risk. In the event of foreclosure, the insurer pays a set amount to the lender to cover some or all of the outstanding loan balance.
Mortgage-Backed Security (MBS). Financial instrument representing an interest in a pool of loans secured by mortgages. Principal and interest payments on the underlying mortgages are used to pay principal and interest on the securities. The generic term encompasses passthrough securities and mortgage-backed bonds. Freddie Mac and Fannie Mae guarantee the timely payment of principal and interest on the mortgage-backed securities they issue.
Mortgage Broker. Company that, for a commission, matches borrowers and lenders. A mortgage broker typically takes the borrower application and sometimes processes the loan but, unlike a mortgage banker, does not use its own funds to close the loan.
Mortgage Insurance. Financial protection paid for by a borrower with the lender as beneficiary, in which a third party--the insurer--assumes some of the default risk of the loan. In the event of foreclosure, the policy pays a set amount to the lender to cover some or all of the loan balance outstanding.
Mortgage Underwriter. Loan company employee who reviews a loan applicant’s credit, loan repayment ability and the value of the collateral property to assess the amount of risk involved in making a loan. Based on the risk analysis, an underwriter recommends whether the lender should make or reject the mortgage and may match the risk to an appropriate rate of interest and term structure.
Multi-Lender Platform. World Wide Web site established as a cooperative venture between several lenders, where borrowers can review a broad selection of mortgage products and rates and use different analytical tools to best match a loan product with their needs.