Question 3.

The MZ Mortgage Company is issuing a CMO with three tranches. The A tranche will consist of $40.5 million with a coupon of 8.25%. The B tranche will be issued with a coupon of 9% and a principal of $22.5 million. The Z tranche will carry a coupon of 10% with a principal of $45 million. The mortgages backing the security issue were originated at a fixed rate of 10% with a maturity of 10 years (annual payments). The issue will be overcollateralized by $4.5 million, and issuer will receive all net cash flows after priority payments are made to each class of securities. Priority payments will be made to the class A tranche and will include the promised coupon, all amortization from the mortgage pool, and interest that will be accrued to the Z class until the principal of $40.5 million due the A tranche is repaid. The B class securities receive interest only payments until the A class is repaid, then receive priority payments of amortization and accrued interest. The Z class will accrue interest at 10% until both A and B classes are repaid. It will receive current interest and principal payments at that time.

Assume a constant annual prepayment rate of 10 percent. For simplicity assume that prepayments are based on the pool balance at the end of the preceding year and begin at the end of year 1.

If class A investors demand an 8.5% yield to maturity at the time of issue, what price should MZ Mortgage Company ask for this security?

Question 4.

If class B investors demand an 9.5% yield to maturity at the time of issue, what would be the price of the class B security?

Question 5.

If class Z investors demand an 9.75% yield to maturity at the time of issue, what would be the price of the class Z security?

Question 6.

What rate of return will be earned on the equity overcollateralization (input solution in decimals to three decimal places)?