1. Lecture 22

2.  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

3.  Implied Volatility is highest where time premium is highest…usually at the money Time Decay Option Price Stock Price Days to Expiration 90 60 30

4.  Term Structure of Volatilities

5. Strike Price Asset Price Implied Volatility

6. Strike Price Asset Price Implied Volatility

7. Strike Price Asset Price Implied Volatility

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

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

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

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