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Cross Calling
       
 
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Cross Calling

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Cross Calling
A method of redeeming bonds using surplus funds provided from an unrelated Bond issue.
    
Cross calling occurs when a lender, which repackages its loans into new securities, uses prepayments from Low Interest rate loans to repay principal on the High-Yield securities.  The practice of cross-calling is seen in the mortgage-backed securities (MBS) market. However, it is seen as taboo because it shifts Risk from High-Yield investors to Low-Yield ones.
    
For example, let's examine a simple bank that has issued two mortgages with Interest rates of 5% and 10%. The bank converts these into mortgage-backed securities and sells them to investors with Coupon rates of 7% and 15%, respectively. Cross calling involves using prepayments from the 5% mortgage to pay principal on the 15% MBS. While this pays off the more risky Bond faster, it forces the 7% bondholders to rely on risky payments from the 10% mortgage. The 7% bondholders are not compensated for the additional Risk and the bank saves by making smaller Interest payments.
Posted by  EBD Group AG
 
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