Consider the following Collateralized Mortgage Obligations (CMOs) with Tranche A and Tranche Z securities issued recently.

Assets: 5-year, 10% fixed rate mortgage pool = $1,200,000

(including an overcollaterization of $200,000)

Tranche A :

Stated maturity 3years

Coupon Rate 6%

Amount Issued = $600,000

Tranche Z:

Stated maturity 5 years

Coupon rate 11%

Amount issued = $400,000

All cash flows are annual.

a)If the current market interest rate for Tranche A is 4%, what is the fair market value of Tranche A?

b)If the current market interest rate for Tranche Z is 9%, what is the fair market value of Tranche Z?

c)Would the effect of prepayment increase or decrease the interest rate risk of Tranche A and Tranche Z securities?briefly explain