Transcript Derivatives
Lecture 23
Valued similar to bonds (fixed incomes)
Factors
Prepayment
Weighted average coupon (WAC)
◦ The monthly payment derived from the interest
rate charged on the loans.
Weighted average maturity (WAM)
Required yield (YTM)
Default (similar to prepayment)
Cash Flow Pattern for Bonds
Bonds
Loan Payment
12
10
8
Interest
Principal
6
4
2
0
1
2
3
4
5
6
Years
7
8
9
10
Cash Flow Pattern for MORTGAGES Reflecting PREPAYMENT
Mortgages
Loan Payment
12
10
8
Interest
Principal
6
4
2
0
1
2
3
4
5
6
Years
7
8
9
10
MBS Valuation
MBA Value = PV of cash flows
Steps
1. Determine the monthly payment
2. Use prepayment assumption to derive
maturity
3. Calculate the PV of the monthly payment at
the YTM.
MBS Valuation
Using present value terminology
PV = Price of MBS
Pmt = monthly coupon payment from MBS
i = Yield to Maturity
n = t = Prepayment year assumption
FV = Balance of mortgage at prepayment
Example
A mortgage pool contains $13,000,000 in
loans made to homeowners. The weighted
average maturity of these mortgages is 22
years. The weighted average interest rate
charged on the loans is 6.5%. If the
mortgage pool requires a risk adjusted
yield to maturity of 7.4%, what is the value
of the mortgage pool?
Example
A mortgage pool contains $13,000,000 in loans made to
homeowners. The weighted average maturity of these mortgages
is 22 years. The weighted average interest rate charged on the
loans is 6.5%. If the mortgage pool requires a risk adjusted yield
to maturity of 7.4%, what is the value of the mortgage pool?
Assume NO prepayment.
Step 1 – Find the monthly payment
PV = $ 13,000,000
FV = 0
n = 264 (22 x 12)
i = 0.54 % ( .065 / 12 )
solving for the PMT
PMT = - 92,682
Example
A mortgage pool contains $13,000,000 in loans made to
homeowners. The weighted average maturity of these mortgages
is 22 years. The weighted average interest rate charged on the
loans is 6.5%. If the mortgage pool requires a risk adjusted yield
to maturity of 7.4%, what is the value of the mortgage pool?
Assume NO prepayment.
Step 2 – Find Present Value of the monthly payments at the YTM
PMT = - 92,682
FV = 0
n = 264 (22 x 12)
i = 0.6167 % ( .074 / 12 )
solving for the PV
PV = $ 12,061,114
Example
A mortgage pool contains $13,000,000 in loans made to
homeowners. The weighted average maturity of these mortgages
is 22 years. The weighted average interest rate charged on the
loans is 6.5%. If the mortgage pool requires a risk adjusted yield
to maturity of 7.4%, what is the value of the mortgage pool?
Instead, assume the loans are completely prepaid at the end of
year 15.
Example
A mortgage pool contains $13,000,000 in loans made to
homeowners. The weighted average maturity of these mortgages
is 22 years. The weighted average interest rate charged on the
loans is 6.5%. If the mortgage pool requires a risk adjusted yield
to maturity of 7.4%, what is the value of the mortgage pool?
Instead, assume the loans are completely prepaid at the end of
year 15.
Step 1 – Same as before. Calculate the monthly payment
PMT = 92,682
Example
A mortgage pool contains $13,000,000 in loans made to
homeowners. The weighted average maturity of these mortgages
is 22 years. The weighted average interest rate charged on the
loans is 6.5%. If the mortgage pool requires a risk adjusted yield
to maturity of 7.4%, what is the value of the mortgage pool?
Instead, assume the loans are completely prepaid at the end of
year 15.
Step 2 – NEW – Calculate the balance at the end of year 15.
PMT = - 92,682
PV = 13,000,000
i = 0.54 % ( .065 / 12 )
n = 180 (15 x 12)
solving for the FV
FV = - 6,241,454
Example
A mortgage pool contains $13,000,000 in loans made to
homeowners. The weighted average maturity of these mortgages
is 22 years. The weighted average interest rate charged on the
loans is 6.5%. If the mortgage pool requires a risk adjusted yield
to maturity of 7.4%, what is the value of the mortgage pool?
Instead, assume the loans are completely prepaid at the end of
year 15.
Step 3 – NEW – Calculate the PV of the new cash flows.
PMT = - 92,682
FV = - 6,241,454
i = 0.6167 % ( .074 / 12 )
n = 180 (15 x 12)
solving for the PV
PV = $ 12,123,449
Example - Analysis
Notice the MBS value drops from $ 12,061,114 to $ 12,123,449 when the
prepayment assumption is added.
Why?
The MBS selling at a discount because the YTM was higher than the
coupon. By getting the money sooner, the discount is reduced.
REMIC - real estate mortgage investment
conduits
Variable maturity tranche
Variable/Fixed rate tranche
IO
PO