Transcript Slide 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
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
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

David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
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
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
Estimating Pool Wide Cashflows
Beg.
Year Pool P & I Prin.
Bal.
1
2
3
4
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
Int.
End.
Pre- Total
Pool
pays CF
Bal.
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
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
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?
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
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%
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
Cash Flows of Mortgage-Backed Bonds
Yr
Beg.
Pool
Bal.
1
2
3
4
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
P & I Prin
Int
Prepays
Def
Total
CFin
PMTs
to
Bond.
Res
Res. End.
Fund Pool
Bal. Bal.