1. Use the options prepayment model to calculate the yield on a $12 million 3-year fully amortized mortgage pass through where the mortgage coupon rate is 7% paid annually. Current market yields are 8% p.a. Assume there is no servicing fee or a GNMA guarantee fee. (Chapter 26)

a. What is the annual payment on the GNMA pass throughs? What is the present value of the GNMA pass throughs?

b. Interest rates movements over time are assumed to change a maximum of 2% up or down per year with equal probability. If interest rates fall to 3% or below, all mortgages in the pool are completely prepaid. What are the GNMA's expected annual cash flows? (Assume no prepayment)

T=0

T=1

T=2

T=3

8% SPOT

Year 1 Cash Flows:

Year 2 Cash Flows:

Year 3 Cash Flows:

c. The Treasury bond yield curve is flat at a discount yield of 6%. What is the option adjusted spread on the GNMA?