Use the following information on a convertible bond issue from for Problems 6 - 10. You are examining a mortgage backed security with the following features: $500 million in underlying mortgages (e.g., principal value = $500 million) Three time tranches, A, B, and C where the par value of A is $200 million, the par value of B is $100 million, and the par value of C is $200 million. A is senior to B and B is senior to C. The weighted average coupon (WAC) is 6%; the pass through rate is 5% The security has a weighted average maturity (WAM) of 3 years and payments are made annually (e.g., so it will only make 3 payments). For Questions 6-7, assume that there is no default and no prepayment. Total MBS Issue: Year Beg. Balance Payment Interest Paid Principal Paid End. Balance 1 2 2 X 3 Tranche A: Year Beg. Balance Interest Paid Principal Paid End. Balance Total Cash Flow 1 2 3 Tranche B: Year Beg. Balance Interest Paid Principal Paid End. Balance Total Cash Flow 1 2 3 Tranche C: Year Beg. Balance Interest Paid Principal Paid End. Balance Total Cash Flow 1 2 Y 3 6. What is the value of X? 7. What is the value of Y? 8. Suppose now that not only were these tranches based on time (e.g., A gets repaid in full before B begins receiving payment) but they are also based on credit (e.g., Cabsorbs all losses before A or B loses a penny). Suppose that investors default on $75 million in loans immediately after the payments in year 1. Redo the tables and obtain the value of Y. 9. Suppose the rate of prepayment increases. Does duration of this MBS increase or decrease? Explain your answer in 1-2 sentences. 10. Suppose interest rates decrease. What would you expect to happen to the duration of this MBS? Would it increase or decrease? Explain your answer in 1-2 sentences. Use the following information on a convertible bond issue from for Problems 6 - 10. You are examining a mortgage backed security with the following features: $500 million in underlying mortgages (e.g., principal value = $500 million) Three time tranches, A, B, and C where the par value of A is $200 million, the par value of B is $100 million, and the par value of C is $200 million. A is senior to B and B is senior to C. The weighted average coupon (WAC) is 6%; the pass through rate is 5% The security has a weighted average maturity (WAM) of 3 years and payments are made annually (e.g., so it will only make 3 payments). For Questions 6-7, assume that there is no default and no prepayment. Total MBS Issue: Year Beg. Balance Payment Interest Paid Principal Paid End. Balance 1 2 2 X 3 Tranche A: Year Beg. Balance Interest Paid Principal Paid End. Balance Total Cash Flow 1 2 3 Tranche B: Year Beg. Balance Interest Paid Principal Paid End. Balance Total Cash Flow 1 2 3 Tranche C: Year Beg. Balance Interest Paid Principal Paid End. Balance Total Cash Flow 1 2 Y 3 6. What is the value of X? 7. What is the value of Y? 8. Suppose now that not only were these tranches based on time (e.g., A gets repaid in full before B begins receiving payment) but they are also based on credit (e.g., Cabsorbs all losses before A or B loses a penny). Suppose that investors default on $75 million in loans immediately after the payments in year 1. Redo the tables and obtain the value of Y. 9. Suppose the rate of prepayment increases. Does duration of this MBS increase or decrease? Explain your answer in 1-2 sentences. 10. Suppose interest rates decrease. What would you expect to happen to the duration of this MBS? Would it increase or decrease? Explain your answer in 1-2 sentences
