Chapter 10b Lecture slides

Chapter 10b Lecture slides - Chapters 10 and 11...

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Chapters 10 and 11 Mortgage-Backed Sector of the Bond Market Major learning outcomes: Securitization and Mortgage-Backed Securities residential mortgage-backed securities, securities backed by commercial loans, referred to as commercial mortgage-backed securities stripped mortgage-backed securities. Collateralized Mortgage Obligations (CMOs)
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Stripped Mortgage-Backed Securities Stripped MBSs consist of two classes: Principal-only (PO) class that receives only the principal from the underlying mortgages. Interest-only (IO) class that receives just the interest.
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Stripped MBS A stripped mortgage-backed security is a mortgage-backed security that is created by redistributing the interest and principal payments to two different classes. A principal-only mortgage strip (PO) benefits from declining interest rates and fast prepayments. An interest-only mortgage strip (IO) benefits from rising interest rates and a slowing of prepayments; if rates fall instead, the investor in an interest-only security may not realize the amount invested even if the security is held to maturity.
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Principal-Only Stripped MBS Because of prepayment, the price of a PO MBS tends to be more responsive to interest rate changes than an option-free bond. That is, if interest rates are decreasing, then like the price of most bonds, the price of a PO MBS will increase. In addition, the price of a PO MBS is also likely to increase further because of the expectation of greater earlier principal payments as a result of an increase in prepayment caused by the lower rates. PO PO V rate discount lower ) 2 ( R V return prepayment ) 1 (
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Interest-Only Stripped MBS Cash flows from an I0 MBS come from the interest paid on the mortgages portfolio’s principal balance. In contrast to a PO MBS, the cash flows and the
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This note was uploaded on 03/19/2011 for the course ACCT 440 taught by Professor Smith during the Spring '11 term at Saginaw Valley.

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Chapter 10b Lecture slides - Chapters 10 and 11...

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