effective interest amortization

effective interest amortization
A methodology for amortizing premiums or accreting discounts for MBSs that is required by FAS 91. Under this methodology, premiums are amortized and discounts are accreted into income over the average life of the securities. To accomplish this, a prepayment speed assumption (PPA) must be made when the MBS is purchased. An average life is then estimated from that prepayment assumption. Then an initial accretion or amortization schedule is determined to evenly spread the accretion or amortization into income over the estimated life of the MBS investment. If actual prepayments received during the life of the investment differ from the assumed speed, as they almost always will, the average life projection must be revised. When the average life projection is revised, a revised accretion or amortization schedule must be calculated for the entire period from the purchase date. In practice, many investors do not do this until the difference between the original speed assumption and a more accurate, current assumption, is material. An alternative system, level factor amortization, is often considered superior. American Banker Glossary

Financial and business terms. 2012.

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