Problem 5

The Green Bank originates a pool of containing 100 30-year fixed-rate mortgages with loan amount of $250,000 each.All mortgages in the pool carry a rate of 6.5% with monthly payments. The servicing fee is 0.05% each month. The Green Bank would like to sell the pool to investors via IO/PO Strips. Suppose that they issue 150,000 shares of IO/PO Strips and the market interest rate is 6%.

Questions

1. Assume that there are no prepayment and no default, how much an investor would like to pay for each share of the IO/PO Strips?

2. What is the price of each share of the IO/PO Strips if there are a constant prepayment rate of 1.5% every month and no default?

3. What is the price of each share of the IO/PO Strips if there are a constant default rate of 1.5% every month (assuming the recovering rate is 50%) and no prepayment?

4. Please briefly discuss your findings.