Cash flows from mortgage- backed security, Financial Management

Assignment Help:

It is a well known fact that the value of a financial claim reflects the present value of the cash flows produced by the financial claim. While valuing an MBS an important thing to be decided upon is with regard to the cash flows, given the nature of the underlying mortgage contracts.

To an MBS investor, cash flows comprises three components,

CFt   =   NIt + SPt + PRt

Where,

CFt   =   total cash flow to investor.

NIt    =     monthly interest payment net of servicing and other fees.

SPt   =   scheduled principal payment for month t.

PRt   =   forecasted unscheduled principal repayments in month t (prepayments).

The significant amount is the prepayment PRt, which occurs at the discretion of the borrowers.

The following table shows the mechanics of a classical pass through MBS.

Table 

Payments of mortgage borrower: PRt + SPt + It

Repayments: PRt + SPt

(Gross) Interest coupon payments: It = i MBt-1

Forecasted unscheduled prepayment: PRt

Monthly scheduled payment of borrowers
(coupon plus amortization on mortgage balance)

 

                   MPt = MBt-1  2064_cash from mortgage security.png

 

Prepayments

PRt = SMMt (MBt-1) - SPt)

Scheduled repayments

 

SPt = MPt - It

Interest net of service fees

 

NLt = MBt-1 (i - s)

Service fee (going to servicer)

 

St = s MBt-1

Cash flow to MBS investors: CFt = PRt + SPt + It - St = PRt + SPt + NIt

 

Where,

It        =   Gross interest coupon payments

MBt     =   Mortgage balance

MPt     =   Monthly scheduled payment of borrowers

SMMt   =     Standard monthly mortality rate, i.e. prepayment rate, which can also be modelled using more sophisticated econometric techniques

St       =     Servicing fee.

Based on the mortgage balance from the previous month, the above process is repeated.

The link between the months follows the dynamic stock adjustment equation

MBt - MBt-1 = PRt + SPt

Through this equation, the events of one period affect the cash flows of all consequent periods. This is also called path-dependency. Undoubtedly, if it was not for the uncertainty of the prepayments, PRt, the process would be perfectly predictable on the basis of knowledge of i, s, n, and MB0.


Related Discussions:- Cash flows from mortgage- backed security

Significant performance indicators, Significant Performance Indicators ...

Significant Performance Indicators   Following are the most commonly used performance indicators used to assess the financial, and general health of any company:   Gro

Cost of capital, The Nu-Nu Brothers Inc. (NNBI) has the following capital s...

The Nu-Nu Brothers Inc. (NNBI) has the following capital structure, which it considers to be optional: Debt 25% Preferred Stock 15% Common Equity 60% NNBI''''s expected net income

Determine about the shareholders, Determine about the Shareholders Shar...

Determine about the Shareholders Shareholders, being the owners of the company, elect board of directors and vote on major issues that affect functioning and long term plans of

How do financial managers calculate the average tax rate, How do financial ...

How do financial managers calculate the average tax rate? Financial managers calculate the average tax rate by dividing tax dollars paid by earnings before taxes (EBT).

Explain the concept of newsworthiness in the field of pr, Question 1: (...

Question 1: (a). A big multinational company wishes to employ a PR manager for all its PR activities. What according to you would be the advantages and disadvantages of having

Discuss the techniques to manage risks, Q. Discuss the techniques to manage...

Q. Discuss the techniques to manage risks? Once risks have been identified and assessed, all techniques to manage the risk fall into one or more of the four major categories li

Securitization, Securitization refers to conversion of illiquid asset...

Securitization refers to conversion of illiquid assets to liquid assets by converting longer duration cash flows into shorter duration ones. Securitization denote

Analytical way of viewing financial problems of a firm, Analytical way of v...

Analytical way of viewing financial problems of a firm The new approach is an analytical way of viewing financial problems of a firm. The main contents of this tactic are what

Does high operating leverage always mean high business risk, Does high oper...

Does high operating leverage always mean high business risk?  Explain. High operating leverage does not all the time mean high business risk.  If the companies sales are quite

Standard deviation for every project, AOT limited is considering two mutual...

AOT limited is considering two mutually exclusive projects - cable and satellite.  The possible NPVs for every project and their associated probabilities are as follows: Cable:

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd