Money Pit Bank (MPB) is originating a pool of 75 ten-year fixed interest mortgages with an average balance of $100,000 each. All mortgages in the pool carry a coupon of 12% (For simplicity, assume all mortgage payments are made annually at 12% interest). MPB intends to sell the loans to Freddie Mac.
Assuming a constant annual prepayment rate of 10% (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 MPB can expect to obtain for the pool of mortgages if interest rates (discount rate) are a) 11%, b) 12% and c) 9%?
Assume that 5 years have passed since the date in question 1). If market interest rates are 12%, what price can MPB obtain now?
Instead of selling the pool of mortgages MPB decides to securitize the mortgages issuing 100 pass-through securities. The coupon rate will be 11.5% and the servicing and guarantee fee will be 0.5%. However, the current market rate of return is 10.5%. How much will MPB obtain for this offering of mortgage pass-through(s)? What will each purchaser pay for a security, assuming the same prepayment rate as in question 1)?
Assume now that immediately after purchase in question 3), interest rates fall to 9% and the prepayment rates are expected to accelerate to 20% per year, beginning at the end of the first year. What will the security be worth now?