What is the major difference between a CMO and the other types of mortgage-related securities


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What value per share is indicated using a dividend discount model



1i. The Provincial Insurance Company has the choice of investing $100,000 in either a mortgage bond with annual payments based on a 10-year amortization schedule with a maturity of five years at 10 percent or a 5-year corporate bond with annual interest payments and a final principal payment also yielding 10 percent.

a.Find the duration of each instrument if they are issued at par.

b.If the market rate of interest on each bond fell from 10 percent to 7 percent and the durations found in part (a) remained constant, what would be the new price for each bond?


1ii.You have been presented with the following set of financial statements for National Property Trust, a REIT that is about to make an initial stock offering to the public. This REIT specializes in the acquisition and management of warehouses. Your firm, Blue Street Advisors, is an investment management company that is considering the purchase of National Property Trust shares. You have been asked to prepare a financial analysis of the REIT.


a.Develop a set of financial ratios that will provide Blue Street Advisors with useful information in the evaluation and comparison of National Property Trust with other REITs.

b.Your research also indicates that the shares of comparable REITs specializing in warehouse acquisitions in the same regions are selling at dividend yields in the range of 8 percent. Price multiples for these REITs are about 12 current FFO. What price range does this suggest for National shares? What does this price range imply about the amount of dividend that National would have to pay to be in line with comparable REITs?

c.What is the NAV for National Property Trust assuming that a blended capitalization rate of 10 percent would be applicable for the properties owned by Blue Street Advisors?


1iii. What is a mortgage pay-through bond (MPTB)?  How does it resemble a mortgage-backed bond (MBB)?  How does it differ?


2i. Robust Properties is planning to go public by creating a REIT that will offer 1 million shares of stock. It is currently trying to develop a pro forma set of financial statements. Robust is faced with a number of questions about its handling of some accounting and financial disclosure issues.


The management of Robust Properties has asked you to prepare preliminary pro forma financials for the next three years. Specifically, you should have (1) a beginning balance sheet,  (2) operating statements for each of the next three years, and (3) all relevant financial ratios for year 1 results only. Robust will pay all financing fees, tenant improvements, and lease commissions upon commencing operations. It would like to pay a minimum dividend of $4.00 per share.

In preparing your pro forma operating statements, Robust wants you to consider the effects of reporting in the following two ways:

a.What would EPS, FFO, and ROC be under both approaches? How should Robust think about its accounting policy?



2ii. Are the over collateralization requirements the same for mortgage pay-through bonds as for the mortgage-backed bonds?


3ii. Atlantis REIT expects an income of $8.00 per share. This includes a deduction of $2.00 per share for depreciation. Atlantis did not have any gains from the sale of real estate. Its properties are mainly apartments, and you believe that apartments are currently selling on average at about an 8 percent cap rate. Atlantis has 1 million shares outstanding and its balance sheet shows liabilities of $40 million. Comparable REITs have FFO multiples of about 10. Atlantis is expected to pay a dividend during the next fiscal year of $6.00 per share and to increase those dividends at about 2 percent per year in the future. Investors in REITs like Atlantis usually expect a return of about 12 percent.

a.What is the FFO and value per share based on an FFO multiple?

b.What value per share is indicated using a dividend discount model?

c.What is the value per share implied by the net asset value of the properties?


3ii. Name two different ways that MPTBs can be over collateralized.


4i.Excel. Refer to the “Ch20 CMO” tab in the Excel Workbook provided on the Web site. What is the return on the residual class for prepayment rates of 15 percent, 20 percent, 25 percent, and 30 percent?


4ii.What is a CMO?  Explain why a CMO has been called as much of a marketing innovation as a financial innovation.


5i. Excel. Refer to the “Ch20 Floater” tab in the Excel Workbook provided on the Web site. Assume that $15,000,000 in floaters and $5,000,000 in inverse floaters are issued. How does this change the returns for the inverse floater when LIBOR is 2 percent, 4 percent, and 6 percent?


5ii. What is meant by a derivative investment?


6i. Excel. Refer to the “CH20 IO_PO” tab in the Excel Workbook provided on the Web site. What is the return on the IO and PO at prepayment rates of 25 percent and 30 percent?


6ii.Name the four major classes of mortgage-related securities.  As an issuer, explain the reasons for choosing one type over another.


7i.Excel. Refer to the “Ch20 CMBS” tab in the Excel Workbook provided on the Web site. Suppose there is default at maturity and the property sells for 90 percent of the loan balance. What are the returns to the subordinate tranche and residual?


7ii. What is the major difference between a CMO and the other types of mortgage-related securities?


8.Why are CMOs over collateralized?


9.What is the purpose of the accrual tranche? Could a CMO exist without a Z class? What would be the difference between the CMO with and without the accrual class?


10.Which tranches in a CMO issue are least subject to price variances related to changes in market interest rates?  Why?


11.What is the primary distinction between mortgage-related securities backed by residential mortgages and those backed by commercial mortgages?


12.Name the major types of credit enhancement used for commercial-backed mortgage securities.


13.What is a “floater”/”inverse-floater” tranche in a CMO offering?


14.What is the role of the “scaler” in structuring an (F) and (IF) structure?


15.Why would anyone want to purchase an (F) or (IF) derivative type of investment?


16.What are (IO) and (PO) strips? Which tends to be more volatile in price? Why?


17.In what ways is a CMBS structure different from a CMO backed by residential mortgages? Why is default risk in a CMBS offering given more attention?


18.How do CDOs differ from CMBS?

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