Index Amortizing Note (IAN)

What Is an Index Amortizing Note (IAN)?

An index amortizing note (IAN) is a type of structured note or debt obligation. The amount of the principal repayment will increase or diminish following an amortization schedule which has a basis of an index like the London Interbank Offered Rate (LIBOR), the CMT (Constant Maturity Treasury), or the mortgage interest rate.

Understanding Index Amortizing Notes (IAN)

Index amortizing notes are structured to reduce the holder's interest rate risk. The IAN's maturity phase expands when interest rates increase. On the other hand, as interest rates decline, the maturity period shortens. Amortization alludes to paying off a debt over the long haul in standard portions keeping a amortization schedule, which incorporates both interest and principal payments. With IANs, the debt payment time period relies upon the market interest rates.

In spite of the ability to change a note's maturity period, the index amortizing note likewise has a predetermined maximum maturity date. This maturity term is the date by which any leftover principal must be paid.

The maturities of index amortizing notes frequently act like those of collateralized mortgage obligations (CMOs) which have embedded prepayment options. As mortgage prepayment rates decline, in response to expanding market interest rates, the maturity of an IAN will stretch. With an increase in mortgage prepayment rates, in response to decreasing market interest rates, the IAN maturity will shorten. Likewise with other mortgage-backed instruments, an Index Amortizing Note's association with interest rates makes a negative convexity exposure.

Involving Indexes for an Index Amortizing Note

A interest rate index is an index in light of the interest rate of a financial instrument or basket of financial instruments. The index fills in as a benchmark to work out the rate of interest to charge on mortgages and other debt products.

One illustration of an index schedule utilized for an index amortizing note is the LIBOR. This LIBOR index is the benchmark rate which several of the top banks in the world charge each other for short-term loans. The LIBOR sets rates for seven distinct maturity periods and fills in as the reference rate utilized by numerous financial institutions to set rates for loans, for example, mortgages, student loans, and corporate bonds. Lenders will change the interest rates on these loans as per the index as market factors change.

The Intercontinental Exchange, the authority responsible for LIBOR, will stop distributing one-week and two-month USD LIBOR after Dec. 31, 2021. Any remaining LIBOR will be discontinued after June 30, 2023.

Contrasting IANs and Non-Amortizing Loans

Not at all like an Index Amortizing Note, non-amortizing loans have no amortization schedules. Likewise, they don't need the payment of the principal during the life of the loan. All things considered, these loans demand lower payments of interest followed by a lump-sum amount to pay off the excess loan balance. A balloon payment loan is an illustration of a non-amortizing loan. These loans are riskier for lenders due to the deferred payments and accordingly are normally short-term vehicles. Borrowers will frequently refinance, or look for another loan when the balloon payment is due.