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					Collateralized Mortgage Obligations Stripped MBS, and ABS
1. Collateralized Mortgage Obligations 2. Stripped Mortgage-backed Securities

3. Brief introduction of ABS and collateralized debt obligations

Fin431x (Ch 12, 13, 14, 15)

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CMOs
Bond classes created by redirecting the cash flows of mortgage-related products so as to mitigate prepayment risk.

Pay-through structure: there are more than one class of bondholders with the same level of credit priority

Tranches: different bond classes
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Fin431x (Ch 12, 13, 14, 15)

Materials Covered under CMOs
Sequential-Pay Tranches (basic) Accrual Tranche Floater and Inverse Floater Planned Amortization Class versus Support Class

Fin431x (Ch 12, 13, 14, 15)

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Sequential-Pay Tranches
The collateral for the hypothetical CMO is a hypothetical pass-through with total par value of $400 million and the following characteristics : (1) The pass-through coupon rate is 7.5% (2) WAC=8.125% (3) WAM=357 month (4) 165PSA

(page 275):
Fin431x (Ch 12, 13, 14, 15)
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FJF-01
Tranche A B C D
1.

Par Amount 194,500,000 36,500,000 96,500,000 73,000,000 ?

Coupon Rate(%) 7.5 7.5 7.5 7.5

2.

For payment of periodic coupon interest: Disburse periodic coupon interest to each tranche on the basis of the amount of principal outstanding at the beginning of the period For disbursement of principal payments: Disburse principal prepayments to tranche A until it is paid off completely. After tranche A is paid off completely, disburse principal payments to tranche B until it is paid off completely. After … After tranche C is paid off completely, disburse principal payments to tranche D until it is paid off completely.
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Cash flow from Pass through (page 277)
In month 1: total payment=$709,923; Interest=$250,000 In month 81: total payment=

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Cash flow from the CMO
Exhibit 12-2 – split the principal; CMO specifies the order of principal payment The principal pay-down window Average lives for the collateral and four tranches of the CMO – page 279 (ex 12-3).
Fin431x (Ch 12, 13, 14, 15)
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Accrual Bond
One tranches (or more) does (do) not receive current interest. This is an accrual tranche, or Z bond.

Fin431x (Ch 12, 13, 14, 15)

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FJF-02
Tranche A B C Z 1. 2. Par Amount Coupon Rate(%) 194,500,000 7.5 36,500,000 7.5 96,500,000 7.5 73,000,000 7.5 ? For payment of periodic coupon interest For disbursement of principal payments

3.

Solution: see Exhibit 5 – page 281.
Fin431x (Ch 12, 13, 14, 15)
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FJF-03: Floating-rate Tranches
Tranche A B FL IFL Z 1. 2. Par Amount Coupon Rate(%) 194,500,000 7.5 36,500,000 7.5 72,375,000 1-month LIBOR + 0.50 24,125,000 28.5-3*(1-month LIBOR) 73,000,000 7.5 ? For payment of periodic coupon interest For disbursement of principal payments

Fin431x (Ch 12, 13, 14, 15)

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Planned Amortization Class (PAC)
Exhibit 12-8 Tranche P S

Par Amount Coupon rate (%) $243,800,000 7.5 156,200,000 7.5 400,000,000 For payment of periodic coupon interest For disbursement of principal payments
Fin431x (Ch 12, 13, 14, 15)
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Principal Payments under PAC
Disburse principal payments to tranche P based on its schedule of principal repayments. Tranche P has priority with respect to current and future principal payments to satisfy the schedule. Any excess principal payments in a month over the amount necessary to satisfy the schedule for tranche P are paid to tranche S. When tranche S is paid off completely, all principal payments are to be made to tranche P regardless of the schedule.

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Support Bonds
Bodyguards for the PAC bondholders Can be partitioned into classes, I.e, bodyguards have ranks and titles, too.

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Objective
To eliminate the contraction risk and the extension risk Contraction risk: when interest rate goes down Extension risk: when interest rate goes up
Fin431x (Ch 12, 13, 14, 15)
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TAC
One-side prepayment protection. Has a single PSA rate from which the schedule of principal repayment is protected Typically protected when prepayment is high, thus avoid contraction risk.
Fin431x (Ch 12, 13, 14, 15)
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Credit Risk and Tax Treatment of CMOs
Agency CMOs Nonagency CMOs
Interest and principal payments are not taxable.

Fin431x (Ch 12, 13, 14, 15)

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Stripped Mortgage-Backed Securities
Principal-only (PO) securities
when current mortgage rate < coupon rate, prepayment speeds up.  price goes up when current mortgage rate > coupon rate, price drops.

Interest-only (IO) securities
current mortgage rate < coupon rate, mixed

Exhibit 12-14 (page 296) CMO strips: one class in CMO structure could be PO or IO.
Fin431x (Ch 12, 13, 14, 15)
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Asset-backed Securities
Securities created by pooling loans other than first-lien mortgage loans are referred to as asset-backed securities.

4 biggest sectors • Credit card receivables

• Auto loans
• Home-equity loans • Manufactured housing loans

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Cash flows of ABS
Amortizing assets Amortization schedule Absolute prepayment rate (APR) Payment structure – page 334

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Credit Card ReceivableBacked Securities
Page 341. Credit card issuers have receivables IBs use the future cash flows from credit card receivables as collaterals to issue ABS or CDOs

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Collateralized Debt Obligations
A security backed by a diversified pool of one or more of the following types of debt obligations • U.S. domestic investment-grade and high-yield corporate bonds • U.S. domestic bank loans • Emerging market bonds • Special situation loans and distressed debt • Foreign bank loans • Asset-backed securities • Residential and commercial mortgage-back securities

Fin431x (Ch 12, 13, 14, 15)

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Exercises (Ch12)
Problem 13: should be something close to 7.26 years Problem 14: (a) support bond; (b) PAC bond Problem 20: (a) 8.67%, (b) no effect , (c) more stable cash flows and lower variability

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