The Valuation and Hedging of Deferred Commission Asset Backed Securities

Abstract

Due to a timing mismatch between fee receipts and commission payments, there is a new and growing market for securities backed by fees from back-end load and level load mutual funds. This paper develops a contingent claims methodology for the valuation of these securities. The resulting security value depends primarily on the current value of fund assets and the fee schedule. The valuation formula also provides an analytical expression for the appropriate strategy for hedging fluctuations in asset value. As a case study, we investigate the hedging performance of an institution that holds a portfolio of these securities.