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Professor Crocker H Liu Rev 52296

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Professor Crocker H Liu Rev 52296 Powered By Docstoc
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Professor Crocker H. Liu Mortgage Backed Securities Practice Final Exam Multiple Choice (3 points per question) 1. What are the necessary conditions for mortgage-backed securities to exist? a. perfect capital markets b. complete spanning of assets c. value additivity must hold d. all of the above e. none of the above 2. In comparison to mortgage pass-through securities, mortgage backed bonds should be priced: a. to provide lower yields than MPTs because of lower prepayment risks b. to provide higher yields than MPTs because of higher prepayment risks c. to provide the same yield as MPTs because of equivalent amounts of prepayment risk d. none of the above 3. Given the following deal:
_________________________________________________________________________ Issue Date Collateral Principal Coupon Issue Total Size ($000) Type Index Margin CMO Trust 15-A CMO Trust 15-B CMO Trust 15-C CMO Trust 15-D CMO Trust 15-E* Issue 25-Nov-86 100% FHLMC 9 $1,000,000 500,000 188,340 69,300 174,560 67,800 Issue Price Floater 3 Mo. LIBOR + 50 bp ? ? ? ? @Assumed PSA

Rev. 5/22/98

Cap

AvgLife

CMO Trust 15-A 15% 99 24/32 8.5 167% CMO Trust 15-B 95 12/32 2.5 167% CMO Trust 15-C 85 8/32 5.8 167% CMO Trust 15-D 75 8/32 11.0 167% CMO Trust 15-E* 59 20/32 21.6 167% _________________________________________________________________________ *E is not a Z-piece; Homogeneous-coupon collateral Collateral: 100% Freddie Mac 9% MBS Face Amount of Floating Rate Tranche: $500,000,000 Aggregate Face Amount of NonFloating Tranches (B-E): $500,000,000

What is the coupon on the nonfloating tranches? a. 5% b. 3% c. 8% d. None of the above

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4. Which of the following statements are true? I. If the mortgage backed security is to be used as a hedge or to enhance portfolio yield, negative convexity may be acceptable. II. There is not one call but a bundle of calls embedded in the mortgage backed security a. Only I is true b. Only II is true c. Both I and II are true d. Neither I nor II are true 5. Which of the following statements generally holds with respect to CMOs? a. discount-priced CMO bond coupons with high-WAC collateral benefit from slower prepayments b. premium-priced CMO bond coupons with low-WAC collateral benefit from slower prepayments c. discount-priced CMO bond coupons with low-WAC collateral are the most volatile structure and will be priced to a relatively narrow yield spread d. premium-priced CMO bond coupons with high-WAC collateral are the most stable structure and will be priced to a relatively wide yield spread. 6. A TAC bond has all of the following characteristics except a. there is just one PSA speed at which the TAC schedule is satisfied b. if a bond has both a PAC and a TAC class in addition to support bonds, the TAC receives any principal remaining after the PAC requirements are met c. a TAC bond can act as a support bond for a PAC d. all of the above are characteristics of a TAC 7. The new Goldman Sachs prepayment model discussed in Fabozzi differs from the Goldman Sachs prepayment model developed by Richard and Roll which was discussed in class in that the new model includes a. prepayments due to mortgage assumptions b. partial prepayments of mortgages c. prepayments due to refinancing d. all of the above e. only a and b f. only a and c g. only b and c

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8. The vast majority of regularly traded mortgage pass-throughs are issued and/or guaranteed by Ginnie Mae (GNMA), Freddie Mac (FHLMC), or Fannie Mae (FNMA). Which of the following are true about these agencies? I. The guarantee of all 3 agencies carries the full faith and credit of the U.S. government II. The risk premium for pass-throughs guaranteed by all 3 agencies is identical a. Only I is true b. Only II is true c. Both I and II are true d. Neither I nor II are true 9. Based on the information provided below, which tranche is fairly well protected if there is a slow down in prepayments and realizes most of the benefits of a speedup of prepayments?

a. Tranche A b. Tranche B c. Tranche C d. Tranche Z

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10. You are given the following information on matching effective duration with stripped mortgage backed securities (SMBS). Which combination of the market value of the IO and the market value of the Ginnie Mae (GNMA) pass-through should show little price sensitivity to small changes in interest rates e.g. a good hedge?

IO Market Value a. b. a. a. $ 10 mm $ 41 mm $ 60 mm $ 80 mm

PT Market Value $ 90 mm $ 59 mm $ 40 mm $ 20 mm

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Short Essay:: (20 points) Please limit your answer to no more than half a page. In the book Liar’s Poker, discuss what John Meriwether’s strategy was for investing in mortgage-backed securities. More specifically, did Meriwether’s strategy involve betting on whether interest rates were headed up or down? If so, please elaborate on this strategy and if not, what strategy did Meriwether use?

Mathematical Question: ( 25 points per question; 50 points total) 1. Graduated Payment Mortgage: Mr. Kamakawiwoole is applying for a $100,000 GPM loan for 30 years at an interest rate of 8%. Payments would be designed so as to graduate at the rate of 7.5% for 3 years beginning with payments in the second year. What would monthly payments be for Mr. Kamakawiwoole in each of the first 5 years of the loan?

Loan Amount Interest Rate Term Gradation Rate

100,000 0.08 30 0.075 Payment Pd MP1 MP2 MP3 MP4-30

Round all computations to 6 decimals

Graduated Pymt Factor MPVIFA ___________ 11.495782 ___________ 11.495782 ___________ 11.495782 ___________ 132.576786

MPVIF 1.000000 0.923361 0.852596 0.787255 Total

PV ___________ ___________ ___________ ___________ ___________

MP1 MP2 MP3 MP4-30

__________ __________ __________ __________ _

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2. Planned Amortization Class (PAC): Following is yearly data assuming a 325% PSA for the first 6 years on a mortgage pass-through from which a PAC and a support bond are constructed. Class PAC Par Coupon 243800 .085 .085

Orig. Loan 400000 Bal. WAC .090 Service Fee .005 MPT Rate .085 Contract Term WAM MPT Rate PSA 360 357 .075 325

Support 156200 400000

Year Yr 0 1 2 3 4 5 6 Beg. Bal 400,000 375,996 323,294 259,092 206,630 164,630 131,024

Proj. DS(t) 37832 34148 28357 22833 18380 14796

Proj. SP(t) 2736 2700 2451 2159 1901 1674

Proj. I(t) 35096 31448 25906 20674 16480 13123

Proj. PR(t) 24697 51945 61209 49341 39327 31313

Proj. S(t) 1950 1747 1439 1149 916 729

SP+P Proj. R Pymts CF(t) 27433 54645 63660 51500 41228 32987 60579 84346 88126 71025 56792 45380

Proj. Principal End BAL(t) Repaid 372,567 317,922 254,262 202,762 161,534 128,548 27,433 82,078 145,738 197,238 238,466 271,452

If the bands associated with the PAC tranche are at 125% PSA and 250% PSA, what is the PAC sinking fund schedule, the PAC principal, and the principal on the support bond for the first 6 years? PAC Sinking Fund (Princ.) __________ __________ __________ __________ __________ __________

125%PSA 250%PSA SP+PR SP+PR Year Pymts Pymts 0 1 12248 21728 2 23685 43329 3 29941 52247 4 27957 44657 5 25894 37800 6 23986 31983

PAC Principal __________ __________ __________ __________ __________ __________

Support Principal ___________ __________ __________ __________ __________ __________

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Solution Key to Practice Final Exam Multiple Choice (points) 1. e 2. a 3. b 4. c 5. b 6. d 7. e 8. d 9. d 10. b source: Lectures source: Lectures source: Lectures source: Bartlett, Chapter 3 source: Bartlett, Chapter 8 source: Bartlett, Chapter 9 source: Fabozzi, Chapter 9 source: Fabozzi, Chapter 3 source: Fabozzi, Chapter 29 source: Fabozzi, Chapter 14

Short Essay:: (points) Answer: Meriwether’s strategy was not betting on the direction of interest rate movements but rather on setting up hedge strategies, in particular interest rate arbitrage, to capture the spread in yield between different securities affected by interest rates. Usually, the spread relationships are stable but can become quite skewed when interest rate volatility is high (there are large swings in the interest rate) which in turn creates bargains. Meriwether’s computer generated “relative-value” trading strategy determines exactly how cheap those bargains are based on historical price data. This in turn allows him to more accurately play the spread between various securities. Mathematical Question: ( points) 1. Graduated Payment Mortgage: Answer
Loan Amount Interest Rate Term Gradation Rate Payment Period MP1 MP2 MP3 MP4-30 100,000 0.08 30 0.075 Payment MP1*1.0 MP1*1.075 MP2*1.075 MP3*1.075 Graduated Pymt Factor 1.000000 1.075000 1.155625 1.242297

Round all computations to 6 decimals

MPVIFA 11.495782 11.495782 11.495782 132.576786

MPVIF 1.000000 0.923361 0.852596 0.787255 Total

PV 11.495782 11.410864 11.326578 129.660684 163.893908

MP1 MP2 MP3 MP4-30

610.15 655.91 705.11 757.99

= 100,000*163.893908 = 617.53*1.075 = 660.76*1.075 = 707.01*1.075

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2. Planned Amortization Class (PAC): Answer Year Year PAC 125%PSA 250%PSA Sinking SP+PR SP+PR Fund Year Pymts Pymts (Princ.) 0 1 12248 21728 12248 2 23685 43329 23685 3 29941 52247 29941 4 27957 44657 27957 5 25894 37800 25894 6 23986 31983 23986

Year PAC Principal 12,248 23,685 29,941 27,957 25,894 23,986

Year Support Principal 15,185 30,960 33,719 23,543 15,334 9,000


				
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