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Mortgage Price Volatility

This review delves into the intricacies of mortgage price volatility, focusing on the price-yield relationship and the determinants affecting mortgage price fluctuations. Key characteristics such as coupon rate, term to maturity, and yield-to-maturity are examined to quantify the volatility. Discussions include the concepts of duration and modified duration, illustrating their significance in assessing price changes due to yield variations. Examples help clarify the calculations, specifically for fixed-rate mortgages. The analysis provides insights into how embedded options impact mortgage pricing.

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Mortgage Price Volatility

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  1. Mortgage Price Volatility • Review of the Price-Yield Relationship • An increase (decrease) in the required yield… • Price Volatility Characteristics of Mortgages

  2. Determinants of Price Volatility • Characteristics of a Mortgage that Affect Its Price Volatility • Coupon Rate • Term to Maturity • Yield-to-Maturity

  3. Measuring Mortgage Price Volatility • Price Value of a Basis Point • Note: Mortgage Yield Ticks Usually Equal 1/8th of 1%

  4. Duration • Definition - • Derivation:

  5. Calculating Duration • Ex. Consider a $100,000, 6% APR mortgage with 10 years to maturity and an initial yield of 8.0%. What is this mortgage’s duration?

  6. Alternative Duration Derivation • Rewrite the price of a mortgage as the present value of an annuity: • Differentiate with respect to the required yield: • Modified Duration =

  7. Now What??? • Approximate % Change in Price: • Actual % Change in Price: • Conclusions:

  8. Duration Illustrated • Duration attempts to measure… • Conclusions: Price Yield

  9. Approximating Duration • Approximating a Mortgage’s Duration • Example: What is the approximate duration for our 10 year, 6% APR, $100,000 mortgage with 10 years remaining until maturity and an initial yield of 8.0%?

  10. What About Embedded Options???

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