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Yield Maintenance

Yield maintenance is an important part of any loan or bond agreement. It offers both borrowers and lenders protection against the dangers of prepayment and early call. Prepayment can be a risk for lenders because it can lead to a reduction in the interest payments they receive over the life of the loan or bond. It can also be an issue for borrowers, as the lender may charge a higher rate of interest if they are called to repay the loan or bond ahead of schedule.

Yield maintenance can be used to minimize the impact of prepayment risk. To calculate the yield maintenance fee, lenders first calculate the present value of the remaining payments on a mortgage or bond. This amount is then multiplied by the difference between the stated interest rate and the current Treasury yield. This gives the lender a ballpark figure of what would be required in order to make them whole if the loan was prepaid or the bond called early.

Yield maintenance fees vary depending on a number of factors. These can include the amount of time remaining on the loan or bond, the interest rate, the amount of the loan or bond, and the Treasury yield. Yield maintenance premiums also vary depending on the type of loan or bond involved. Generally, shorter-term loans and bonds tend to have higher yield maintenance premiums, while long-term contracts tend to have lower premiums.

Overall, yield maintenance can be an effective way for borrowers and lenders to mitigate prepayment risk. It ensures that lenders are fairly compensated for any reduction in interest payments caused by early payment and discourages borrowers from attempting to settle their debts ahead of schedule. With appropriate planning, yield maintenance can help ensure that both sides of a loan or bond agreement are protected.

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