Mortgage Pass-Through Payment Mechanics Illustrated () Exhibit 19-3 illustrates cash flow patterns that are important when evaluating mortgage pass-through securities. In this exhibit, it is assumed that $1 million of 10 percent fixed interest rate mortgages have been pooled as security for an issue of pass-through securities. The pass-through will carry a coupon, or pass-through, rate of 9.5 percent. The difference between the pooled mortgage rates and coupon rate, or 5 percent, is the servicing fee, which is assessed on the outstanding loan balances. To simplify the discussion, we have assumed that all mortgages in the pool have a maturity of 10 years and that mortgage payments, or cash flows and outflows in and out of the pool, occur annually. 13 The cash flows passed through to individual security holders (column g) are based on annual mortgage payments for a 10 percent, 10 year mortgage on the initial pool balance of $1,000,000, resulting in total principal and interest payments generated by the pool (column c). 14 The servicing fee of .5 percent (column e) is then assessed on the outstanding loan balance at the end of each previous period and subtracted from total principal and interest payments. This results in actual payments to be made to all investors (column f ). Because of the way servicing fees are calculated, payments passed through to investors (column f ) are not the same from year to year, even though payments into the pool (column d) are level. 15 If no mortgages in the pool are prepaid (column c)-that is, all mortgages remain outstanding for their stated maturities-the principal balance in the pool will not reach zero until the end of the 10th year. The amount of cash that will be received by an issuer when this type of pool is formed and securitized depends on the prevailing market rate of return that investors demand on the investment. If it is assumed that, based on the pool characteristics discussed above, the market, or desired, rate of return is equal to the coupon rate ( 9.5% ), then the amount to be received (paid) by the issuers (investors) will be $1 million (or 40 securities with a face value of $25,000 will be sold). This is based on the stream of annual cash flow payments in the exhibit, discounted at 9.5 percent. In this instance, the securities would be sold at par value, or $25,000 each. If the prevailing market rate was 12.5% and prepayment was 0%, then how much would the issuer receive from investors (i.e. what is the purchase price of the entire MBS)? What if there was 10% prepayment, what would the price be with a market rate of 12.5% ? Mortgage Pass-Through Payment Mechanics Illustrated () Exhibit 19-3 illustrates cash flow patterns that are important when evaluating mortgage pass-through securities. In this exhibit, it is assumed that $1 million of 10 percent fixed interest rate mortgages have been pooled as security for an issue of pass-through securities. The pass-through will carry a coupon, or pass-through, rate of 9.5 percent. The difference between the pooled mortgage rates and coupon rate, or 5 percent, is the servicing fee, which is assessed on the outstanding loan balances. To simplify the discussion, we have assumed that all mortgages in the pool have a maturity of 10 years and that mortgage payments, or cash flows and outflows in and out of the pool, occur annually. 13 The cash flows passed through to individual security holders (column g) are based on annual mortgage payments for a 10 percent, 10 year mortgage on the initial pool balance of $1,000,000, resulting in total principal and interest payments generated by the pool (column c). 14 The servicing fee of .5 percent (column e) is then assessed on the outstanding loan balance at the end of each previous period and subtracted from total principal and interest payments. This results in actual payments to be made to all investors (column f ). Because of the way servicing fees are calculated, payments passed through to investors (column f ) are not the same from year to year, even though payments into the pool (column d) are level. 15 If no mortgages in the pool are prepaid (column c)-that is, all mortgages remain outstanding for their stated maturities-the principal balance in the pool will not reach zero until the end of the 10th year. The amount of cash that will be received by an issuer when this type of pool is formed and securitized depends on the prevailing market rate of return that investors demand on the investment. If it is assumed that, based on the pool characteristics discussed above, the market, or desired, rate of return is equal to the coupon rate ( 9.5% ), then the amount to be received (paid) by the issuers (investors) will be $1 million (or 40 securities with a face value of $25,000 will be sold). This is based on the stream of annual cash flow payments in the exhibit, discounted at 9.5 percent. In this instance, the securities would be sold at par value, or $25,000 each. If the prevailing market rate was 12.5% and prepayment was 0%, then how much would the issuer receive from investors (i.e. what is the purchase price of the entire MBS)? What if there was 10% prepayment, what would the price be with a market rate of 12.5%