Drop

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DEFINITION of 'Drop'

The difference in price between the front month and back month in a mortgage-backed security (MBS) dollar roll trade. A dollar roll is a popular type of trade in the MBS pass-through TBA market.

According to forward securities pricing theory, the front month price should be higher than the back month price. The drop is a function of current short-term interest rates, prepayment estimates, and the supply and demand for pass-throughs in the current delivery or front month.

INVESTOPEDIA EXPLAINS 'Drop'

A pass-through TBA security is said to be trading through fail when the drop is larger than what it would cost a mortgage originator, investor or securities dealer to fail to deliver into a TBA contract for an entire month. When there is a shortage of supply or extreme demand for a TBA security in the current delivery month, the drop can increase to fail or larger, reflecting the fact that securities dealers would rather roll a trade out an additional month at a large drop or fail to deliver that security for an entire month than make delivery in the current month.

RELATED TERMS
  1. To Be Announced - TBA

    A term used to describe a forward mortgage-backed securities ...
  2. Mortgage-Backed Security (MBS)

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  3. Forward Price

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  4. Dollar Roll

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  5. Pass-Through Security

    A pool of fixed-income securities backed by a package of assets. ...
  6. Total Annual Loan Cost (TALC)

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