Suppose we have a new type of MBS to accommodate the short-term investor. This new MBS security instrument contains only 3-year mortgages (in reality are rare if non-existent). ACME, a private secondary mortgage market, has pooled together ten $100,000 3-year mortgage loans. Note: To save space in writing out your work, you can scale the ten $100,000 to $100. Calculate the duration for this MBS pool assuming annual compounding for three years at 10 percent interest which

a. is a zero coupon.

b. is an interest-only MBS. Page 2 of 4

c. is fully amortizable over the three years.

part 2 ) Now assume that the interest-only MBS in problem 1b. is prepayable (but not defaultable). Use the option-theoretic model to price this MBS. Interest rates have a 50% chance of going up 1% each year and a 50% chance of going down 1% each year. From your results, qualitatively compare the MBS value without prepayment to the MBS value with prepayment. Note: To save space in writing out your work, you can scale the ten $100,000 to $100. in your solution show the work/setup which includes the calculations for all steps in Slide 17s Option Pricing Lecture

Need part 2 not part 1 thanks! please show work