Assume FRM 30 yr. = 5%. Consider the following 2 MBS MBS 1 Coupon = 5.25% MBS 2

ID: 2760935 • Letter: A

Question

Assume FRM 30 yr. = 5%. Consider the following 2 MBS

MBS 1 Coupon = 5.25%

MBS 2 Coupon = 4.25%

Pool average coupon = 6.5%

Pool average coupon = 4.5%

Threshold = 100 BPs

Which MBS is a premium and which is a discount. Explain.

Determine relative prepayment speed for both MBS1 and MBS2

Assume the FRM falls by 100BPS. What is the effect on prepayment speed for both MBS securities? Explain.

Explain how negative convexity is evident as a result of #3 above.

MBS 1 Coupon = 5.25%

MBS 2 Coupon = 4.25%

Pool average coupon = 6.5%

Pool average coupon = 4.5%

Threshold = 100 BPs

(1) MBS 1 is at preium as pool avereage coupon is higher than the mbs 1 coupon of 5.25%

and MBS 2 is at discount as pool average coupon is no much higher than its coupon rate

(2) Prepayments in case of MBS 1 is faster than MBS 2 as pool avereage is more

(3) the FRm falls by 100 BPs means 1% then it become 4% and MBS 2 is also at better than previous position

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