What it means
In a TBA trade, the two sides agree on only a handful of terms: the issuer or programme, the maturity, the coupon (the interest rate paid on the bond), the price, the face amount and the settlement date. The exact pools that will be delivered are not named at the time of the trade, which is why the market is called "to be announced".
The seller must tell the buyer which pools it will deliver shortly before settlement, usually two business days earlier. The pools must meet standard "good delivery" rules, so the buyer knows that whatever arrives will be broadly similar to what it expected.
This standardisation is what makes the market so liquid. TBA trading matters because it lets mortgage lenders offer borrowers a fixed rate weeks before the loan closes.
A lender can sell the future loans forward in the TBA market, fixing the price and protecting itself if rates move in the meantime. Without it, mortgage rates would be higher and more volatile.
Settlement happens once a month on dates set by the industry body for each class of security. Traders who do not want to take delivery can roll the position forward to the next month, usually by selling the near month and buying the later one, a trade known as a dollar roll.
The price difference between the months reflects financing costs and the value of the interest and principal that would be received. There is a catch for buyers.
Because the seller chooses which pools to deliver, it will tend to hand over the least valuable ones that still meet the rules, a behaviour known as the cheapest-to-deliver option. Investors who want specific features, such as loans with low balances, therefore pay a premium to buy specified pools instead of TBAs.
Buyers and sellers also face counterparty and settlement risk until the trade closes. Firms manage this through margin, trading limits and confirmations, and the market has well-established rules to reduce disputes.
In practice
Real-world examples.
Example
A mortgage lender expects to close $20,000,000 of home loans next month. It sells the matching amount of securities in the TBA market today, locking in a price so that a rise in rates before closing does not wipe out its profit.
Example
A pension fund wants exposure to home loans without choosing individual pools. It buys $30,000,000 of TBAs for its bond portfolio because they are easy to trade, widely quoted and can be rolled forward.
Example
A hedge fund thinks mortgage rates will rise. It sells TBAs short and rolls the position each month, planning to buy them back later at a lower price if it is right.
Formula
Calculation
Purchase price = Face amount x (Price / 100), plus accrued interest
An investor agrees to buy $5,000,000 face value of 30-year mortgage-backed securities at a price of 98.5 for settlement next month. The purchase price before accrued interest is $5,000,000 x (98.5 / 100) = $5,000,000 x 0.985 = $4,925,000. The investor pays this amount, plus any accrued interest, at settlement, and the specific pools are announced two business days before.Case study
Seen in the real world.
Cedar Lane Mortgage is an illustrative, fictional lender that originates about $50,000,000 of home loans a month. Its treasurer, Hannah, noticed that borrowers locked their rates up to 60 days before closing, leaving the company exposed if market rates rose.
She hedged by selling TBAs against the expected pipeline of loans and adjusted the hedge each week as applications came and went. When rates rose sharply one month, the value of the lender's unclosed loans fell, but the gain on the TBA hedge largely offset the loss.
In this fictional story, the hedge kept the lender's margin steady. Hannah's lesson was that the hedge only works if the pipeline forecast is accurate, so she began tracking how many locked loans actually closed.
Watch out
Common mistakes.
- Assuming the buyer knows exactly which mortgage pools it will receive at the time of the trade.
- Treating a TBA as a risk-free instrument, when prices move with interest rates and prepayment speeds.
- Forgetting that sellers can deliver the cheapest pools that meet the rules, which can reduce the value of what the buyer gets.
Questions
People also ask.
When are the pools actually announced?
They are normally announced about two business days before the settlement date.
Why does the TBA market matter to homebuyers?
It lets lenders hedge in advance, which supports the availability of fixed-rate mortgages at predictable prices.
What is a dollar roll?
It is a pair of trades in which an investor sells TBAs for the near month and buys them back for a later month, effectively financing the position.
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