Measurement of the Spreads Between Yields on Various Mortgage Contracts and Treasury Securities

Spreads between yields on different mortgage instruments and comparable maturity portfolios of Treasury securities have been computed and compared with quoted yields over the 1974–82 period for three different mortgage instruments: GNMA pass‐throughs, FHLMC participation certificates, and conventional mortgage commitments. The methodology explicitly accounts for the expected timing of the payments on the mortgages and thus avoids the cash‐flow timing problems noted in the literature. Between late 1978 and 1981, the computed spreads rose by 30 to 40 basis points relative to those customarily quoted (the internal rate of return on a mortgage, assuming a twelve‐year life, less the yield on near‐par ten‐year Treasuries). This increase can be attributed to the rise in the level of interest rates (the compounding error in quoted mortgage yields is larger at higher levels of rates) and the change in the slope of the yield curve from flat to downward sloping (the twelve‐year prepayment date assumed in the computation of quoted GNMA and FHLMC PC yields seems to be too long).