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Questions and Answers of Corporate Finance

Consider the following fixed-rate, level-payment mortgage: maturity = 360 months amount borrowed = $100,000 annual mortgage rate = 10% (a) Construct an amortization schedule for the first 10
Explain why, in a fixed-rate mortgage, the amount of the mortgage payment applied to interest declines over time, while the amount applied to the repayment of principal increases.
Why is the cash flow of a residential mortgage loan unknown?
In what sense has the investor in a residential mortgage loan granted the borrower (homeowner) a loan similar to a callable bond?
What is meant by strategic default behavior?
What is the advantage of a prepayment penalty mortgage from the perspective of the lender?
Explain whether you agree or disagree with the following statements:a. “Freddie Mac and Fannie Mae are only allowed to purchase conforming conventional loans.”b. “In packaging loans to create a
What are the two primary factors in determining whether or not funds will be lent to an applicant for a residential mortgage loan?
Answer the below questions.(a) What features of an adjustable-rate mortgage will affect its cash flow?(b) What are the two categories of benchmark indexes used in adjustable-rate mortgages?
Answer the below questions.(a) What is the original LTV of a mortgage loan?(b) What is the current LTV of a mortgage loan?(c) What is the problem with using the original LTV to assess the likelihood
For mortgage loans, what is prepayment risk?
Explain why the higher the loan-to-value ratio is, the greater the credit risk is to which the lender is exposed.
What is the difference between a cash-out refinancing and a rate-and-term refinancing?
What are the front ratio and back ratio, and how do they differ?
What is the difference between a prime loan and a subprime loan?
How are FICO scores used in classifying loans?
What is an alternative-A loan?
What is an FHA-insured loan?
Answer the below questions.a. Explain what is meant by a residential mortgage-backed security.b. Describe the sectors of the residential mortgage-backed securities market.
How does the guarantee for a Ginnie Mae mortgage-backed security differ from that of a mortgage-backed security issued by Fannie Mae and Freddie Mac?
On October 1, 2005, Fannie Mae issued a mortgage pass-through security and the prospectus supplement stated the following:FANNIE MAEMORTGAGE-BACKED SECURITIES PROGRAMSUPPLEMENT TO PROSPECTUS DATED
Why is an assumed prepayment speed necessary to project the cash flow of a pass-through?
What does a conditional prepayment rate of 8% mean?
Indicate whether you agree or disagree with the following statement: “The PSA prepayment benchmark is a model for forecasting prepayments for a pass-through security.”
Answer the below questions.(a) Complete the following table:(a) Complete the following table:
Complete the following table (in thousands of dollars) assuming a prepayment rate of 165 PSA:Original balance: $ 100,000,000Pass-through rate: 9.0%WAM: 360 months
Answer the below questions.(a) What is meant by prepayments due to housing turnover?(b) What is meant by prepayments due to cash-out refinancing?(c) What is meant by prepayments due to rate/term
Answer the below questions.(a) What factor can be used as a proxy for cash-out refinancing incentives?(b) Why are prepayments attributable to cash-out refinancing likely to be insensitive to changes
What is the S-curve for prepayments? Explain the reason for the shape.
What is a mortgage pass-through security?
What is the burnout effect?
Answer the below questions.(a) What is the cash flow yield of a mortgage pass-through security?(b)What are the limitations of cash flow yield measures for a mortgage pass-through security?
What is the bond-equivalent yield if the monthly cash flow yield is 0.7%?
What is the average life of a pass-through, and what does it depend on?a. What are contraction risk and extension risk?b. Why would a pass-through with a WAM of 350 months be an unattractive
Answer the below questions.(a) Distinguish between a TBA and specified pool trade.(b) What delivery options are granted to the seller in a TBA trade?
What are the two types of private–label MBS?
What are subprime mortgage-backed securities?
What is meant by a derivative mortgage-backed security?
Describe the cash flow of a mortgage pass-through security.
Answer the below questions.(a) What are the WAC and WAM of a pass-through security?(b) After origination of a mortgage-backed security, the WAM changes. What measures are used by Fannie Mae and
Although it is often stated that Ginnie Mae issues mortgage-backed securities, why is that technically incorrect?
What are the different types of agency pass-through securities?
How does a CMO alter the cash flow from mortgages so as to shift the prepayment risk across various classes of bondholders?
Explain the role of a support bond in a CMO structure.
What was the motivation for the creation of PAC bonds?
Suppose that a savings and loan association has decided to invest in mortgage-backed securities and is considering the following two securities: (i) a Freddie Mac pass-through security with a WAM of
Suppose that a PAC bond is created assuming prepayments speeds of 80 PSA and 350 PSA. If the collateral pays at 100 PSA over its life, what will this PAC tranche’s average life be?
Suppose that $1 billion of pass-throughs is used to create a CMO structure with a PAC bond with a par value of $700 million and a support bond with a par value of $300 million.Answer the below
Suppose that the $1 billion of collateral in Question 14 was divided into a PAC bond with a par value of $800 million and a support bond with a par value of $200 million. Will the PAC bond in this
Suppose that $1 billion of pass-throughs is used to create a CMO structure with a PAC bond with a par value of $700 million (PAC I), a support bond with a schedule (PAC II) with a par value of $100
In a CMO structure with several PAC bonds, explain why, when the support bonds are paid off, the structure will be just like a sequential-pay CMO.
Suppose that for the first four years of a CMO, prepayments are well within the initial PAC collar. What will happen to the effective upper collar?
Consider the following CMO structure backed by 8% collateral:TranchePar Amount (in millions)Coupon Rate (%)A$3006.50%B$2506.75%C$2007.25%D$2507.75%Suppose that a client wants a notional IO with a
What is the difference between a REMIC and a CMO?
An issuer is considering the following two CMO structures. The first structure is:Tranches A to E are a sequence of PAC I€™s and F is the support bond. The second structure is:Tranches A to E are
Answer the below questions.(a) What is the role of a lockout in a CMO structure?(b) Explain why in a reverse PAC bond structure the longest average life bond can turn out to be effectively a support
Answer the below questions.(a) What type of prepayment protection is afforded a TAC bond?(b) What type of prepayment protection is afforded a reverse TAC bond?(c) What type of prepayment protection
Answer the below questions.(a) What is a PO security? What is an IO security?(b) How is the price of an interest-only security expected to change when interest rates change?
Suppose that 8% coupon pass-throughs are stripped into two classes. Class X-1 receives 75% of the principal and 10% of the interest. Class X-2 receives 25% of the principal and 90% of the interest.
Answer the below questions. (a) “By creating a CMO, an issuer eliminates the prepayment risk associated with the underlying mortgages.” Do you agree with this statement?(b) Wall Street often
In a discussion of the CMO market, the popular press sometimes refers to this sector of the mortgage-backed securities market as the riskiest sector and the pass-through sector as the safest sector.
Explain the effect on the average lives of sequential-pay structures of including an accrual tranche in a CMO structure.
What types of investors would be attracted to an accrual bond?
Suppose that a tranche from which an inverse floater is created has an average life of five years. What will the average life of the inverse floaterbe?
This quotation is taken from a 1991 issue of BondWeek:First Interstate Bank of Texas will look into buying several different types of collateralized mortgage obligation tranches when it starts up its
Describe how the schedule for a PAC tranche is created.
Answer the below questions.a. Why is it necessary for a nonagency mortgage-backed security to have credit enhancement?b. Who determines the amount of credit enhancement needed?
Why might an interest rate derivative such as an interest rate swap or interest rate cap be used in a securitization transaction for residential mortgage loans?
Why is a shifting interest mechanism included in a securitization where the collateral is residential mortgage loans?
Suppose that for a securitization with a shifting interest mechanism you are given the following information for some month:subordinate interest = 25%shifting interest percentage = 85%regularly
What is the purpose of the step-down provisions in a securitization?
What is meant by the prospectus prepayment curve?
Answer the below questions.a. What is meant by an involuntary prepayment?b. Why is the distinction between a voluntary and involuntary prepayment important in non agency RMBS?
When will a mortgage servicer not advance payments for principal and interest?
Why does the treatment of modified loans in a nonagency RMBS deal impact the bond classes?
There are some mortgage loans that are balloon loans. This means that when the loan matures, there is a mortgage balance that will require financing. It is the responsibility of the borrower to
Suppose that the loans in the collateral pool for a nonagency RMBS deal have a floating rate. What is the risk associated with issued fixed-rate bond classes?
What is the difference between a private-label and subprime mortgage-backed security? Be sure to mention how they differ in terms of credit enhancement.
What is the concern with the inclusion of fixed-rate mortgage loans in the collateral pool when the liabilities are floating rate?
An interest rate cap allows the buyer of the cap to be compensated if interest rates rise above a reference rate. The buyer has to pay a periodic premium to obtain this protection. When an RMBS
Answer the below questions.a. What is an option ARM loan?b. Why is it unlikely that this loan type will be originated in the future?
Answer the below questions.a. At one time, prime and subprime RMBS were traded in separate markets. Why?b. Why after 2007 are prime and subprime RMBS treated as one asset type?
a. What is meant by a senior-subordinated structure?b. Why is the senior-subordinated structure a form of credit enhancement?
How can excess spread be a form of credit enhancement?
Answer the below questions.a. What is the difference between credit tranching and prepayment tranching?b. Why would there be both types of tranching in a nonagency deal but only one type of tranching
a. What is the conditional default rate?b. What is the cumulative default rate?
Why was the PSA Standard Default curve introduced?
How is the net operating income (NOI) of a commercial property determined?
In a commercial mortgage-backed security, what is the concern that the bondholders have when there is a prepayment premium paid by a borrower?
The following appears on the web site of Chatham Financial, an advisory service: “Kennett Square, Pa., June 21, 2010 — Chatham Financial announced today that it advised Primus Capital in the
Explain why commercial mortgage-backed securities do not trade like residential mortgage-backed securities in the market.
Answer the below questions.a. With respect to the mitigation of balloon risk, what is meant by an internal tail?b. With respect to the mitigation of balloon risk, what is meant by an external tail?
Answer the below questions.a. Explain the cross-collateralization feature and its significance in a single-borrower / multiproperty CMBS transaction.b. Explain the cross-default feature and its
Answer the below questions.a. How does a single-borrower/multiproperty deal differ from a conduit deal?b. What is meant by a fusion conduit deal?
What are the typical duties of a special servicer?
How does the analysis of a commercial mortgage-backed security differ from that of a residential mortgage-backed security?
Why is it not adequate to look at the weighted-average debt-to-service coverage ratio and weighted-average loan-to-value ratio for the pool of commercial mortgage loans in assessing the potential
Why is it important to look at the dispersion of property types and geographical location of properties in analyzing a CMBS transaction?
Why might an investor be skeptical about the loan-to-value ratio for a commercial mortgage loan?
Explain the underlying principle for a yield maintenance charge.

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