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.