A FIXED-INCOME PORTFOLIO MANAGER PURCHASES A SEASONED 5.5% AGENCY...
18.
A fixed-income portfolio manager purchases a seasoned 5.5% agency mortgage-backed security with a
weighted average loan age of 60 months. The current balance on the loans is USD 20 million, and the condi-
tional prepayment rate is assumed to be constant at 0.4% per year. Which of the following is closest to the
expected principal prepayment this month?
a.
USD 1,000
b.
USD 7,000
c.
USD 10,000
d.
USD 70,000
Correct Answer: b
Rationale:
The expected principal prepayment is equal to: 20,000,000 * (1-((1-0.004)^(1/12))) = USD 6,679.
Section:
Financial Markets and Products
Reference:
Pietro Veronesi, Basics of Residential Mortgage Backed Securities, Chapter 8.
Learning Objective:
Describe and work through a simple cash flow example for the following types of MBS:
Pass-through securities.
Reference:
Bruce Tuckman, Fixed Income Securities, 3rd Edition, Chapter 20, “Mortgages and Mortgage-Backed
Securities.”
Learning Objective:
Calculate a fixed rate mortgage payment, and its principal and interest components. Describe
the mortgage prepayment option and the factors that influence prepayments.
2015 Financial Risk Manager (FRM®) Practice Exam