Learning objectives: Describe the various types of residential mortgage products. Calculate a fixed-rate mortgage payment and its principal and interest components. Summarize the securitization process of mortgage-backed securities (MBS), particularly the formation of mortgage pools, including specific pools and to-be-announceds (TBAs). Calculate the weighted average coupon, weighted average maturity, single monthly mortality rate (SMM), and conditional prepayment rate (CPR) for a mortgage pool. Describe the process of trading pass-through agency MBS.
Questions:
23.3.1. Three years ago, Mary purchased a house in the United States. Her down payment was 20% of the $900,000 purchase price; therefore, the original balance on her mortgage loan was $720,000. Her loan was a typical 30-year fixed-rate, fully-amortizing loan with an interest rate of 6.0% per annum with monthly compound frequency. As of today (i.e., exactly 36 months after origination), which of the following is nearest to the loan's outstanding principal balance?
a. $550,733
b. $691,805
c. $703,294
d. $871,805
23.3.2. At the request of his boss at a large commercial bank, Jason is using the bank's internal model to perform a valuation of a freshly constructed pass-through mortgage-backed security (MBS) pool. The pool contains about 500 mortgages with a principal value of $400 billion; all of the mortgages originated within the last 30 days. The pool's weighted average coupon (WAC) is 7.50%. Jason is going to assume a PSA rate of 140%. This multiplies by 1.40 the baseline 100% PSA rate that starts at 0.20% CPR each month for 30 months, then levels at 6.0% CPR. Each of the following is true EXCEPT which is false?
a. The pass-through security will pay investors a coupon rate less than 7.50%
b. The pool factor declines over time due to both scheduled and unscheduled prepayments
c. An increase in the assumption for the PSA rate (e.g., 140% to 170%) implies an increase in present value of this pool
d. The single month mortality (SMM) rate excludes scheduled prepayments, and after three years, it will be about 0.7285%
23.3.3. In regard to agencies and agency mortgage-backed securities (agency MSB), each of the following is true EXCEPT which is false?
a. The agencies protect investors against curtailments but not defaults
b. GNMA is a government agency, but FNMA and FHLMC are private companies
c. Pass-through agency securities trade as either specified pools or as to-be-announced (TBAs) in a more liquid forward market
d. The dollar roll trade is similar to a repo transaction except (i) explicit interest is not added to the repurchase price and (ii) the front-month securities sold do not need to be identical to the back-month delivered securities
Answers here:
Questions:
23.3.1. Three years ago, Mary purchased a house in the United States. Her down payment was 20% of the $900,000 purchase price; therefore, the original balance on her mortgage loan was $720,000. Her loan was a typical 30-year fixed-rate, fully-amortizing loan with an interest rate of 6.0% per annum with monthly compound frequency. As of today (i.e., exactly 36 months after origination), which of the following is nearest to the loan's outstanding principal balance?
a. $550,733
b. $691,805
c. $703,294
d. $871,805
23.3.2. At the request of his boss at a large commercial bank, Jason is using the bank's internal model to perform a valuation of a freshly constructed pass-through mortgage-backed security (MBS) pool. The pool contains about 500 mortgages with a principal value of $400 billion; all of the mortgages originated within the last 30 days. The pool's weighted average coupon (WAC) is 7.50%. Jason is going to assume a PSA rate of 140%. This multiplies by 1.40 the baseline 100% PSA rate that starts at 0.20% CPR each month for 30 months, then levels at 6.0% CPR. Each of the following is true EXCEPT which is false?
a. The pass-through security will pay investors a coupon rate less than 7.50%
b. The pool factor declines over time due to both scheduled and unscheduled prepayments
c. An increase in the assumption for the PSA rate (e.g., 140% to 170%) implies an increase in present value of this pool
d. The single month mortality (SMM) rate excludes scheduled prepayments, and after three years, it will be about 0.7285%
23.3.3. In regard to agencies and agency mortgage-backed securities (agency MSB), each of the following is true EXCEPT which is false?
a. The agencies protect investors against curtailments but not defaults
b. GNMA is a government agency, but FNMA and FHLMC are private companies
c. Pass-through agency securities trade as either specified pools or as to-be-announced (TBAs) in a more liquid forward market
d. The dollar roll trade is similar to a repo transaction except (i) explicit interest is not added to the repurchase price and (ii) the front-month securities sold do not need to be identical to the back-month delivered securities
Answers here:
