You work for a pension fund that wants to diversify its portfolio by investing in mortgagebacked securities$.$ The fund has identified a potential deal, but it needs your help to model

the cash flows, especially because the underwriters have chosen not to follow the typical PSA

approach. The prospectus states that the deal coupon is $6\mathrm{.}6\%,$ the WAM is $360$ months, and

the loan stratification is provided in the following table:

Net Note Rate Balance in Cohort

$4\mathrm{.}382\%1,300,000$

$4\mathrm{.}441\%6,800,000$

$4\mathrm{.}810\%13,100,000$

$4\mathrm{.}923\%14,600,000$

$5\mathrm{.}011\%19,100,000$

$5\mathrm{.}662\%22,100,000$

$5\mathrm{.}717\%22,600,000$

$5\mathrm{.}829\%23,500,000$

$5\mathrm{.}999\%20,200,000$

$6\mathrm{.}091\%18,100,000$

$6\mathrm{.}226\%16,600,000$

$6\mathrm{.}373\%14,100,000$

$6\mathrm{.}498\%12,000,000$

$6\mathrm{.}680\%3,100,000$

$6\mathrm{.}705\%1,600,000$

$2$

Finally, the prospectus indicates that prepayments should be modeled using the PPC

approach with the following ramp: $2-12\%$ CPR over the first $35$ months.$$

$1.$ Use this information to prepare a monthly cash flow statement for your firm to

understand what they can expect to earn if they invest in the entire security.

$2.$ Using a money$-$weighted return calculation, what is your firm$$s expected return on

this investment?

After presenting these numbers to your colleagues, they have a brainstorming session where

they float the idea of separating the MBS into a PO strip and an IO strip. They ask you to

model how differently the investment would look if they purchased one of these strips.

$3.$ Add two new columns to the cash flow statement: a PO strip cash flow and an IO

strip cash flow. Calculate these two sets of cash flows for each month.

$4.$ Using the money$-$weighted return calculation, what is your firm$$s expected PO strip

return and their expected IO strip return?

$5.$ Why are these returns different? What different risks do they represent?

please show formula and answers thanks