SDSU Annual Compounding for New MBS Security Instrument Research Paper

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Hi Bianca,

You helped me the other day on homework. I was wondering if you are interested in another homework problem to do? This is the following problem……..

Submission instructions: compute and handwrite solutions submit all work/setup which calculations

1a-c. Suppose we have a new type of MBS to accommodate the short-term investor. This new MBS security instrument contains only 5-year mortgages (in reality are rare if non-existent). ACME, a private secondary mortgage market, has pooled together ten $100,000 5-year mortgage loans. Note: To save space in writing out your work, you can scale the ten $100,000 to $100.

Calculate the duration for this MBS pool assuming annual compounding for three years at 10 percent interest which

a.is a “zero coupon”

b. is an interest-only MBS.

c. is fully amortizable over the five years.

2. Now assume that the interest-only MBS in problem 2b. is prepayable (but not defaultable). Use the option-theoretic model to price this MBS. Interest rates have a 50% chance of going up 1% each year and a 50% chance of going down 1% each year. From your results, qualitatively compare the MBS value without prepayment to the MBS value with prepayment. Note: To save space in writing out your work, you can scale the ten $100,000 to $100. – in your solution show the work/setup which includes the calculations for all steps in Slide 17’s Option Pricing Lecture

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