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# Chapter 12 - 6 Question Why can’t we use the binomial...

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1 Chapter 12 – Valuing MBS and ABS 1. Cash flow yield: Formula and limitations of such a measure 1. BEY = 2[(1+i m )^ 6 – 1]; compute BEY if monthly yield is 0.6% (answer=7.31%) 2. Limitations: reinvestment risk, price risk (if security is traded before maturity) and CF risk 2. What are the limitations of the nominal spread and zero volatility spread for MBS? 3. A Monte Carlo simulation model for valuing MBS 1. Simulate interest rate paths and cash flows, using assumptions concerning benchmark rates, rate volatility and prepayment rates 2. Calculate the PV of the cash flows along each interest rate path 3. Calculate the theoretical value of the MBS as the average of the PV along each path 4. Calculate the OAS as the spread that makes the theoretical value=market price 5. Calculate the option cost = Zero volatility spread – OAS
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Unformatted text preview: 6. Question: Why can’t we use the binomial model to value an MBS 4. The concept of OAS – its computation (in Monte Carlo) and interpretation 5. Deciding whether an MBS security is Rich/Cheap using OAS analysis 6. Computation of Effective Duration using the Monte Carlo simulation model 7. Why does effective duration reported by various dealers and vendors differ? 8. Other duration measures: Cash flow, coupon curve and empirical and their limitations 9. Summarize nominal spread, zero volatility spread and OAS to evaluate a fixed income security 10. Analyze the interest rate risk of a security given the security’s duration, convexity, OAS or PVBP. 11. End of chapter questions – 1, 2, 7, 9, 11, 13, 14, 20 12. Homework problems...
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