Lecture 22.  Only non-observable variable  Historical volatility  Predictive models ◦ ARCH (Robert Engel) ◦ GARCH  Weighted Average Historical Volatility.

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Presentation transcript:

Lecture 22

 Only non-observable variable  Historical volatility  Predictive models ◦ ARCH (Robert Engel) ◦ GARCH  Weighted Average Historical Volatility  Implied Volatility  VIX – Exchange traded volatility option ◦ 1993 ◦ S&P 500 Implied Volatility

 Implied Volatility is highest where time premium is highest…usually at the money Time Decay Option Price Stock Price Days to Expiration

 Term Structure of Volatilities

Strike Price Asset Price Implied Volatility

Strike Price Asset Price Implied Volatility

Strike Price Asset Price Implied Volatility

 Ginnie Mae (Govt guaranteed)  Freddie Mac (Private)  Fannie Mae (Private)  Mortgage Conduits  Funding sources for mortgages  How mortgages and MBS are created

 MBS – Mortgage backed security  CMO - collateralized mort obligations ◦ CDO – Collateralized debt obligation  REMIC - real estate mortgage investment conduits  Subprime mortgages ◦ Private label funding

Stripped Mort backed Securities (SMBS)  Variable maturity tranche  Variable/Fixed rate tranche  Principal Only (PO)  Interest Only (IO)

Valued similar to bonds (fixed incomes) Factors  Prepayment  Weighted average coupon (WAC)  Weighted average maturity (WAM)  Required yield (YTM)  Default

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