CAS Exam 9 Spring 2019, Question 9
Study guide: Exam 9
Two mortgages each with principal value of $50,000 are grouped into a $100,000 mortgage pool from which a collateralized mortgage obligation (CMO) is created with the following structure:
- Short-Pay Tranche A: $3,000 principal
- Intermediate-Pay Tranche B: $37,000 principal
- Long-Pay Tranche C: $60,000 principal
Assume:
- The annual mortgage rate is 5%
- Immediately after the first monthly payment, a prepayment of 25% occurs on each outstanding loan
- All proceeds from prepayment go to Tranche C
- The monthly payment on each mortgage loan is $943.56 and remains constant even after prepayment
- Payments are made at end of each month
Part a (1.5 points)
Calculate the nominal value of the first principal payment to Tranche B.
Part b (0.5 points)
Briefly explain how mortgage-backed securities are similar to callable bonds and identify the shape of the yield curve in a low interest rate environment.
Part c (0.75 points)
Identify three reasons why Tranche C carries more risk than Tranche A.
No current syllabus covers this question; it is kept for the record.
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