What Is the Difference Between the Contract or Stated) Yield

question 14

Essay

What is the difference between the contract or stated) yield and the realistic expected return ex ante) on a mortgage? Why is this difference important?
Answ: The contract yield is the stated yield to maturity for a loan based on the loan's contractual provisions. In contrast, the expected return on the loan is the probabilistic expectation of what the realized return on the loan will be for the investor in holder of) the loan. The latter recognizes the possibility and expected impact of default and resulting credit losses in the loan, while the contractual yield does not recognize this effect. The difference is important because the possibility of default is a part of reality, and the investor must consider this when weighing the trade-off between risk and return in the loan as an investment, and in comparing a given loan or type of loan as an investment) with the other investment opportunities available in the capital market.

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