1. 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

2. 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

3. 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 1- 1.3%; 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

4. 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. 1 2 3 4

5. 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

6. 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: 105.125  Revised yield: 10.25%  Revised price: 104.25  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?

7. 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%

8. 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. 1 2 3 4