Posted by Robert Merton on July 16, 2002 at 23:22:44:
My understanding is they work something like this: buy note for 1/2 (or whatever is negotiated) remaining balance. Offer seller option to buy back note for a limited by by paying the note buyer 1/2 remaining balance. You get: monthly payments offering a high yield *but* are forced to reinvest on seller redemptions. Seller gets: cash now, plus an opportunity to redeem note (and possibly satisfy seller's remorse). If I have figured this correctly, yield if redeemed is much less than yield to maturity, because of declining redemption amount. It also seems that one cannot "improve" the note using the usual techniques before the option expires, otherwise your yield drops because the seller redeems on an accelerated discount. Is this correct? What's a typical redemption period? This seems like a good way to acquire more notes at higher yield by playing into the psychology of the seller. The seller might ordinarily balk at a 50% offer, but a buyback option might be just the thing to swing the deal. Has anybody here tried this technique? How successful has it been for you?