Fixed Income: Mortgage Backed Securities

Question 1

Interest Only Strips (MBS)

Answer 1

1. Collect only interest payments from mortgage pool
2. If rates rise, prepayments drop and interest payments stay high for a longer period
3. Worried about contraction risk

Question 2

Principle Only Strips (MBS)

Answer 2

1. Collect only principle payments from mortgage pool
2. Discount security so falling interest rates = quicker return of capital
3. Worried about extention risk

Question 3

Single Month Mortality Rate/ Conditional Prepayment Rate / Estimated Monthly Prepayment

Answer 3

1. SMM = 1 - (1 - CPR)^1/12
2. CPR = 1 - (1 - SMM)^12
3. EMP = SMM X (MBSo - Principle)

Question 4

PSA (Has to do with )

Answer 4

PSA benchmark for conditional prepayment rate (CPR)

1. Assumed to be .02% in month one and increases .02% per month until month 30.
2. Remains at 6% after month 30 until 100% PSA

Question 5

PAC Tranche vs. Support Tranche

Answer 5

Planned Amortization Class

• They have priority on principle payments over other classes
• The non PAC classes are “support” tranches with uncertain paybacks

Question 6

Effective Collar on PAC Tranche

Answer 6

The PSA speeds within which the PAC tranche has protection from the support tranches.