Fin 4319-Record C2

Question 1

what is a cmo?

Answer 1

collateralized mortgage obligations -a mortgage backed bond issued in multiple classes or tranches

Question 2

what is a tranche?

Answer 2

a bond holder class associated with a CMO

Question 3

a sequential pay cmo

Answer 3

any prepayments go to class 1 first until full principal been repaid, and then principle payments go to class 2 until they are paid off, it goes to 3, and 4. the duration is more certain.

Question 4

who loan origination experts/brokers?

Answer 4

they sell these mortgages to those who form pools, and the sell to co.

Question 5

what is the duration of class 1, 2, 3, 4?

Answer 5

short term, int term, long term, very long term.

all classes have negative convexity

Question 6

who invests in short term?

Answer 6

banks, savings accounts and CD’s

Question 7

who invests in intermediate term tranche?

Answer 7

property casualty co.,

Question 8

long term tranche?

Answer 8

pensions funds, life insurance

Question 9

very long term tranche?

Answer 9

endowment funds, life insurance

Question 10

when did CMO’s start?

Answer 10

1960’s by freddie mac

Question 11

how create 3 tranches shorter term than

Answer 11

z class accrual bond

Question 12

PAC and Support Bond

Answer 12

Planned Amortization Class - fixed average life over wide range of prepayment speeds, borrow cash-flow from the support bond or add cash flow to support bond in order to create planned amortisation. it has a fixed average life, it would have positive convexity

Question 13

which trades higher PAC or support bond?

Answer 13

support bond, they buy it for higher yield but less predictable life and duration. negative convexity. for investors don’t need to immunise

Question 14

For PAC, what is the yield? life or duration? convexity?

Answer 14

Lower yield, stable duration, positive convexity

Question 15

For Support, what is the yield? life or duration?

Answer 15

Higher yield, less predictable duration, negative convexity

Question 16

What is PSA?

Answer 16

public securities association (PSA) is a prepayment speed benchmark expressed as a monthly series of annual prepayment rates.

Question 17

What is CPR?

Answer 17

annual prepayment rate

Question 18

how do you compute average life of mortgage pool at speeds?

Answer 18

average life of 100 to be 11-12 years.

Question 19

what is average life of MBS?

Answer 19

The average life of a mortgaged backed security is the average time to receipt of principal payments (scheduled principal payments and projected prepayments), weighted by the amount of principal expected.

Question 20

For CMO what happens when interest rates fall and prepayment speed is high?

Answer 20

the average life could get shorter, 4-5 yrs,

Question 21

For CMO what happens when interest rates rise?

Answer 21

no body refinance so prepayment speed slows, average life or duration ~15-18 years, that’s why you get negative convexity

Question 22

how does the Support Bond help the PAC?

Answer 22

the support bond takes the prepayment risk so the PAC can be more stable

Question 23

agency striped mortgage backed securities

Answer 23

it is a derivative mortgage security created by Fannie Mae.

Question 24

are derivatives bad?

Answer 24

no derivatives are tools to help manage risk, it’s the person using them are bad

Question 25

what is PO?

Answer 25

principle only - assuming 100 PSA, life is 11 years - very sensitive to interest rate change, when rates go down, cash flow goes up and prepayment faster, when rates go up, cash flow goes down, prepayment slows down. asset duration is long, when prepayment is faster, you bet

Question 26

for po, what if prepayment speed is faster than expected?

Answer 26

make it worth more

Question 27

for po, what if you think prepayment speed will be faster than expected?

Answer 27

you will betting interest rates will fall, prepayment speed go faster, PO is great for speculator

Question 28

What is IO?

Answer 28

interest only - don’t know interest payments going to be - if people pay early, not much interest

Question 29

what happens to IO with interest rates?

Answer 29

int rates fall: IO decrease value, prepayment faster, and investor receives less interest
int rates rise: IO increase value, prepayment slows, and you receive more interest payments

Question 30

what is the duration of IO?

Answer 30

it has a negative duration

Question 31

why you buy IO?

Answer 31

you bet interest rise

Question 32

how does IO move compared to most fixed income securities?

Answer 32

security moves opposite of most fixed income securities

Question 33

how do you hedge (or protect against) contraction risk?

Answer 33

buy PO because it has positive duration to lengthen duration of portfolio

Question 34

how do you hedge (or protect against) extension risk?

Answer 34

buy IO because it has negative duration to shorten duration of portfolio

Question 35

what is the market for the actual commodity?

Answer 35

spot market or cash market