What are the similarities and differences between mortgage securities and corporate bonds


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What is the function of the optional delivery commitment?


1i. Two 25-year maturity mortgage-backed bonds are issued. The first bond has a par value of $10,000 and promises to pay a 10.5 percent annual coupon, while the second is a zero coupon bond that promises to pay $10,000 (par) after 25 years, including accrued interest at 10 percent. At issue, bond market investors require a 12 percent interest rate on both bonds.

a.What is the initial price on each bond?

b.Assume both bonds promise interest at 10.5 percent, compounded semiannually. What will be the initial price for each bond?

c.If market interest rates fall to 9.5 percent at the end of five years, what will be the value of each bond, assuming annual payments as in (a) (state both as a percentage of par value and actual dollar value)?


1ii.What is the secondary mortgage market?  List three reasons why it is important.


2i. The Green S & L originated a pool containing 75 ten-year fixed interest rate mortgages with an average balance of $100,000 each. All mortgages in the pool carry a coupon of 12 percent. (For simplicity, assume all mortgage payments are made annually at 12 percent interest.) Green would now like to sell the pool to FNMA.

a.Assuming a constant annual prepayment rate of 10 percent (for simplicity assume that prepayments are based on the pool balance at the end of the preceding year and begin at the end of year 1), what is the price that Green could obtain if market interest rates were (1) 11 percent? (2) 12 percent? (3) 9 percent?

b.Assume that five years have passed since the date in (a). What will the pool factor be? If market interest rates are 12 percent, what price can Green obtain now?

c.Instead of selling the pool of mortgages in (a), Green decides to securitize the mortgages by issuing 100 pass-through securities. The coupon rate will be 11.5 percent and the servicing and guarantee fee will be 0.5 percent. However, the current market rate of return is 10.5 percent. How much will Green obtain for this offering of MPTs? What will each purchaser pay for an MPT security, assuming the same prepayment rate as in (a)?

d.Assume now that immediately after purchase in (c), interest rates fall to 9 percent and that the prepayment rates are expected to accelerate to 20 percent per year, beginning at the end of the first year. What will the MPT security be worth now?


2ii. What were the three principal activities of FNMA under its 1954 charter?  What is its principal function now?


3i.Excel. Refer to the “Ch19 MPS” tab in the Excel Workbook provided on the Web site.  a. Find the value of the cash flows to the issuer and to individual investors based on a required rate of return of 7.5 percent.  b. Find the value of the cash flows to the issuer and to individual investors based on a required rate of return of 11.5 percent.


3ii. Name two ways that FNMA currently finances its secondary mortgage operations.


4.When did GNMA come into existence? What was its original function? What is its main function now?


5.Why was the formation of FHLMC so important?


6.What is a mortgage-related security? What are the similarities and differences between mortgage securities and corporate bonds?


7.Name the principal types of mortgage-related securities. What are the difference between them?


8.There are several ways that mortgages can be sold in the secondary market.  Choose two and compare and contrast their length of distribution channel, relative ease of transaction, and efficiency as it relates to maximizing funds flow from sale.


9.What is the function of the optional delivery commitment?


10.What is a mortgage swap certificate?


11.Name five important characteristics of mortgage pools. Tell why each is important.


12.In general, would a falling rate of market interest cause the price of an MPT security to increase or decrease? Would the increase or decrease be greater if the security was issued at a discount? Would an increase in prepayment be likely or unlikely?  Describe with an example.

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