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Mortgage-backed securities: IO & PO strips BOA originates 100 Fully Amortizing Fixed Rate Mortgages, each has a $1,000 balance, 5% interest rate (no fees), 25-year

Mortgage-backed securities: IO & PO strips

BOA originates 100 Fully Amortizing Fixed Rate Mortgages, each has a $1,000 balance, 5% interest rate (no fees), 25-year term, and annual payments. BOA immediately issues IO and PO strips backed by the pool of these mortgages and sells them to investors who discount payoffs at 4%. Hint: use the Prepay.xlsx file on Blackboard, especially the last years HW7 example.

7. What profits does BOA make immediately? (the answer will be a few million dollars, an 8-digit number)

8. What is the value of all PO strips?

9. What would be the value of all PO strips if the expected prepayment rate was 15% per year?

10. What would be the value of all PO strips if instead the expected default rate was 10% per year? Assume that in case of default, BOA recovers 85% of balance (i.e. default is prepayment but you receive only 80% of the `prepaid balance).

Please answer #8

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