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Valuation of Mortgage Securities

Valuation of Mortgage Securities. Interest-rate Contingent Securities The Importance of Prepayment Modelling Expected Prepayments Average Prepaid Life Constant Prepayment Rate FHA Experience Public Securities Association (PSA) Model Others. Types of Mortgage Backed Securities.

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Valuation of Mortgage Securities

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  1. Valuation of Mortgage Securities • Interest-rate Contingent Securities • The Importance of Prepayment • Modelling Expected Prepayments • Average Prepaid Life • Constant Prepayment Rate • FHA Experience • Public Securities Association (PSA) Model • Others

  2. Types of Mortgage Backed Securities • Commonly Observed Securities • Pass-Throughs • Mortgage-Backed Bonds • Collateralized Mortgage Obligations • Interest Only (I/O) Strips • Principal Only (P/O) Strips • Servicing Rights

  3. Valuing Mortgage Securities • Given the following information about a pool of fixed-rate mortgages: Amount: $110 million Coupon Rate: 11% % PSA: 100% Year 1- 1.3%; Year 2 – 3.7%; Year 3, 5.75%; Year 4 – 6.0% • For the first 4 years, show: • The end-of-year pool balance • Scheduled principal and interest payments • Total cash flows

  4. Estimating Pool Wide Cashflows

  5. Effective Duration of Pass-Throughs • Problems with standard duration • Timing of future CF’s? • Amount of future CF’s? • Impossible to calculate! • Effective (Implied) Duration

  6. Calculating Effective (Implied) Duration • Consider the following price and yield data: • Initial yield: 10.00% • Price: 105.125 • Revised yield: 10.25% • Revised price: 104.25 • Calculate Effective Duration: • Would the duration calculated be greater or less if the price change did not reflect a change in the assumed PSA prepayment rate? Why?

  7. Mortgage-Backed Bonds • Mortgage Pool Data: • Amount: $120 million • Coupon rate: 11% • Maturity: 30 years • % PSA: 0% • Default rate: 0.5% for first 5 years • Bond Data: • Amount: $110 million • Coupon rate: 10% • Maturity: 20 years • Yield on fund: 7%

  8. Cash Flows of Mortgage-Backed Bonds

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