Sunday, August 24, 2008

TBA vs Dollar Roll

Investors are said to “roll” their MBSs if they execute a simultaneous TBA sell order for one settlement month and a buy order for the same MBS issue in the same amount (such as $10 million of Freddie Mac 30-year 5.5%) for the next settlement month.

The TBA market structure of settlement dates is perceived to enhance liquidity by concentrating trading in a particular product (like 30-year conventionals) into a single settlement date each month. Dollar rolls provide a mechanism to help ease supply/demand imbalances for a particular settlement month. (Dealer is buy august/sept roll).

For example, if a dealer is having trouble obtaining collateral for a new August CMO deal that is about to close, the dealer could bid up the August/September roll (by essentially bidding up the price of August settlement collateral) to a level that induces an investor to do the roll (by essentially selling the collateral to the dealer for August settlement and purchasing the collateral for September settlement). If supply for September settlement is sufficient, this provides a means of alleviating a shortage of collateral for August settlement.

A dollar roll is analogous to a repo, but there are important differences: (1) the party borrowing the securities in a dollar roll does not have to return the same securities, but can instead return “substantially similar” ones; and (2) the original owner gives up principal and interest to the temporary holder of the securities (assuming record dates are passed during the period of the roll).

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