David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Valuation of Mortgage Securities Interest-rate Contingent Securities The Importance of Prepayment Modelling Expected Prepayments Average Prepaid Life Constant Prepayment Rate FHA Experience Public Securities Association (PSA) Model Others
David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Types of Mortgage Backed Securities Commonly Observed Securities Pass-Throughs Mortgage-Backed Bonds Collateralized Mortgage Obligations Interest Only (I/O) Strips Principal Only (P/O) Strips Servicing Rights
David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Valuing Mortgage Securities Given the following information about a pool of fixed-rate mortgages: Amount:$110 million Coupon Rate:11% % PSA:100% Year %; Year 2 – 3.7%; Year 3, 5.75%; Year 4 – 6.0% For the first 4 years, show: The end-of-year pool balance Scheduled principal and interest payments Total cash flows
David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Estimating Pool Wide Cashflows Year Beg. Pool Bal. P & IPrin.Int. Pre- pays Total CF End. Pool Bal
David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Effective Duration of Pass-Throughs Problems with standard duration Timing of future CF’s? Amount of future CF’s? Impossible to calculate! Effective (Implied) Duration
David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Calculating Effective (Implied) Duration Consider the following price and yield data: Initial yield: 10.00% Price: Revised yield: 10.25% Revised price: Calculate Effective Duration: Would the duration calculated be greater or less if the price change did not reflect a change in the assumed PSA prepayment rate? Why?
David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Mortgage-Backed Bonds Mortgage Pool Data: Amount: $120 million Coupon rate: 11% Maturity: 30 years % PSA: 0% Default rate: 0.5% for first 5 years Bond Data: Amount: $110 million Coupon rate: 10% Maturity: 20 years Yield on fund: 7%
David M. Harrison, Ph.D. Real Estate Finance Texas Tech University Cash Flows of Mortgage-Backed Bonds Yr Beg. Pool Bal. P & IPrinInt Pre- pays Def Total CF in PMTs to Bond. Res Res. Fund Bal. End. Pool Bal