This collection of slides provides an idea of the course structure and key words.

It is NOT intended to substitute the textbooks and readings required by the lecturer. Accompanying materials may be found on the website. Questions and comments please send to hiep.nm@ftu.edu.vn
1

TCH401
FINANCIAL MARKETS AND INSTITUTIONS Nguyen Manh Hiep

CHAPTER 6
THE MORTGAGE MARKET Nguyen Manh Hiep

In this chapter:
I.

OVERVIEW OF THE MORTGAGE MARKET

SECURITIZATION OF MORTGAGES

II.

III.

RISK OF MORTGAGEBACKED SECURITIES

4

I. OVERVIEW OF THE MORTGAGE MARKET

Self-study.
(Refer: Madura 9th Chapter 9; Mishkin 7th Chapter 14)

II. SECURITIZATION OF MORTGAGES

Self-study.
(Refer: Madura 9th Chapter 9; Mishkin 7th Chapter 14)

III. RISK OF MORTGAGEBACKED SECURITIES

In this section we consider prepayment risk of mortgage-backed securities in the US. CPR (conditional prepayment rate): annual prepayment rate.

SMM (single monthly mortality rate): monthly prepayment rate = 1 (1 CPR)^(1/12).

PSA prepayment benchmark: assumes increasing prepayment rate.
(Refer: CFAI Level 2 Volume 5 SS15)

III. RISK OF MORTGAGEBACKED SECURITIES

Example: PSA prepayment benchmark for 30-years mortgages: CPR = 0.2% for the 1st month, increasing by 0.2% per month up to 30 months.

CPR = 6% from month 30th to 360th .

Prepayment at end of month t = SMMt*(beginning balance of month t scheduled principal payment for month t)
(Refer: CFAI Level 2 Volume 5 SS15)

III. RISK OF MORTGAGEBACKED SECURITIES

Example: 100 PSA: month 5: CPR = 1%, SMM = ?; month 25: CPR = 5%, PSA = 0.05, SMM = ?. Example: 150 PSA: month 5: CPR = 1%*150%=0.015. SMM = ?. Month 25: CPR = ?. SMM = ?.

(Refer: CFAI Level 2 Volume 5 SS15)

III. RISK OF MORTGAGEBACKED SECURITIES

CMO (collateralized mortgage obligation): redistribute the cash flows from a mortgage pool into different risk packages (called tranches) suitable for diverse investors. Example: Sequential pay CMO

III. RISK OF MORTGAGEBACKED SECURITIES

CMO (collateralized mortgage obligation): redistribute the cash flows from a mortgage pool into different risk packages (called tranches) suitable for diverse investors. Example: Sequential pay CMO

(Refer: CFAI Level 2 Volume 5 SS15)

III. RISK OF MORTGAGEBACKED SECURITIES

Example: PAC (Planned Amortization Class) CMO: Original mortgage pool is divided into PAC tranche and support tranche. Two principal repayment schedules establish the initial PAC collar for PAC tranche. PAC tranche bondholders receive the lesser amount of the two payment schedules. Support tranche (companion) absorbs all prepayment risk within the collar.
(Refer: CFAI Level 2 Volume 5 SS15)

III. RISK OF MORTGAGEBACKED SECURITIES

Example: PAC (Planned Amortization Class) CMO:

(Refer: CFAI Level 2 Volume 5 SS15)

III. RISK OF MORTGAGEBACKED SECURITIES

Example: PAC (Planned Amortization Class) CMO: If prepayment speed move out the collar, PAC tranche suffers prepayment risk, PAC tranche average life changes.
(Refer: CFAI Level 2 Volume 5 SS15)

III. RISK OF MORTGAGEBACKED SECURITIES

Example: PAC (Planned Amortization Class) CMO:

(Refer: CFAI Level 2 Volume 5 SS15)

III. RISK OF MORTGAGEBACKED SECURITIES

PO (principal-only) and IO (interest-only) strips

(Refer: CFAI Level 2 Volume 5 SS15)

End of Chapter 6

17