What it is:
How it works/Example:
Mortgage-backed securities (MBS) trade in the secondary market as to-be-announced trades. This means that the specific mortgages that actually make up a mortgage-backed security in a given trade are indeterminate at the time of the trade's execution.
The mortgage allocations procedure requires the seller of a mortgage-backed security to give the buyer information regarding the mortgages the buyer will receive when the trade settles. The seller must convey this information to the buyer 48 hours prior to 3 p.m. on the settlement date.
For example, suppose Jack sells Bob mortgage-backed security ABC on Monday. At the time of the sale, neither Bob nor Jack know which mortgages will make up mortgage-backed security ABC. Consistent with trade-date-plus-three (T+3) settlement rules, Jack contacts Bob on Tuesday before 3 p.m. with the mortgage allocations Bob can expect to receive 48 hours later on Thursday at 3 p.m.
Why it matters:
As to-be-announced trades, the actual values of mortgage-backed securities are essentially estimated at the time they are traded. For this reason, the total value of the underlying mortgages that eventually comprise the security upon settlement cannot deviate by more than one-hundredth of a percent (0.01) of the price of the trade.