Problem
The Blue Mortgage Company has 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. (Assume that all mortgage payments are made annually at 12% interest). Blue would now like to sell the pool to FNMA.
I. Assuming a constant annual prepayment rate of 10 percent (assume that prepayments are based on the pool balance at the end of each year), what will be the price that Blue should obtain on the date of issuance if market interest rates were 11 percent? What if they were 12 percent? What if they were 9 percent?
II. Assume that five years have passed since the date in (I). What will the pool factor be? If market interest rates are 12 percent, what price can Blue obtain then?
III. Instead of selling the pool of mortgages in (I), Blue 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 .5 percent. However, the current market rate of return is now 10.5 percent. How much will Blue obtain for this offering of MPTs? What will each purchaser pay for an MPT security, assuming the same prepayment rate as in (I)?
IV. Assume now that immediately after purchase in (I), 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?