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Financial Institutions Management A Risk Management Approach 6th Edition Anthony Saunders, Marcia Cornett - Solutions
1. An FI originates a pool of short-term real estate loans worth $20 million with maturities of 10 years and paying interest rates of 9 percent per year.What is the average payment received by the FI, including both principal and interest, if no prepayment is expected over the life of the loan?
1. What is a principal only (PO) strip? What causes the price-yield profile of a PO strip to have a steeper slope than a normal bond?
1. What is an interest only (IO) strip? How do the discount effect and the prepayment effect of an IO create a negative duration asset? What macroeconomic effect is required for this negative duration effect to be possible?
1. What are four reasons why an FI may prefer the use of either pass-through securities or CMOs to the use of MBBs?
1. From the perspective of risk management, how does the use of MBBs by an FI assist the FI in managing credit and interest rate risk?
1. What are mortgage-backed bonds (MBBs)? How do MBBs differ from passthrough securities and CMOs?
1. Why would buyers of class C tranches of collateralized mortgage obligations (CMOs) be willing to accept a lower return than purchasers of class A tranches?
1. How does a class Z tranche of a CMO differ from a class R tranche? What causes a Z class to have characteristics of both a zero-coupon bond and a regular bond? What factors can cause an R class to have a negative duration?
1. How can the CMO issuer earn a positive spread on the CMO?
1. Assume nonamortization of principal and no prepayments. What are the total promised coupon payments to the three classes? What are the principal payments to each of the three classes for the first year If, over the first year, the trustee receives quarterly prepayments of $10 million on the
1. Construct a 30-year CMO using this mortgage pool as collateral. The pool has three tranches, where tranche A offers the least protection against prepayment and tranche C offers the most protection against prepayment.Tranche A of $50 million receives quarterly payments at 9 percent per year,
1. What are the interest and principal repayments over the first year of life of the mortgages? What are the principal repayments?
1. What is the quarterly mortgage payment?
1. Consider $200 million of 30-year mortgages with a coupon of 10 percent per year paid quarterly.
1. What is a collateralized mortgage obligation (CMO)? How is it similar to a pass-through security? How does it differ? In what way does the creation of a CMO use market segmentation to redistribute prepayment risk?
1. What conditions would cause the yield on pass-through securities with prepayment risk to be less than the yield on pass-through securities without prepayment risk?
1. What are the expected annual cash flows for each possible situation over the five-year period?
1. Interest rate movements over time are assumed to change a maximum of 1 percent per year. Both an increase of 1 percent and a decrease of 1 percent in interest rates are equally probable. If interest rates fall 3 percent below the current mortgage coupon rates, all mortgages in the pool will be
1. Use the options prepayment model to calculate the yield on a $12 million, five year, fully amortized mortgage pass-through where the mortgage coupon rate is 7 percent paid annually. Market yields are 8 percent paid annually. Assume that there is no servicing or GNMA guarantee fee.
1. The Treasury bond yield curve is flat at a discount yield of 6 percent. What is the option-adjusted spread on the GNMA pass-through?
1. What are the expected annual cash flows for each possible situation over the three-year period?
1. Interest rate movements over time are assumed to change a maximum of 0.5 percent per year. Both an increase of 0.5 percent and a decrease of 0.5 percent in interest rates are equally probable. If interest rates fall 1.0 percent below the current mortgage coupon rates, all of the mortgages in the
1. What is the annual payment on the GNMA pass-through?
1. Use the options prepayment model to calculate the yield on a $30 million three-year fully amortized mortgage pass-through where the mortgage coupon rate is 6 percent paid annually. Market yields are 6.4 percent paid annually. Assume that there is no servicing or GNMA guarantee fee.
1. How does the price on a GNMA bond relate to the yield on a GNMA option from the perspective of the investor? What is the option-adjusted spread (OAS)?
1. What is the goal of prepayment models that use option pricing theory? How do these models differ from the PSA or empirical models? What criticisms often are directed toward these models?
1. What other factors may be helpful in modeling the prepayment behavior of a given mortgage pool?
1. What is the burnout factor? How is it used in modeling prepayment behavior?
1. What factors may cause the actual prepayment pattern to differ from the assumed PSA pattern? How would an FI adjust for the presumed occurrence of some of these factors?
1. What does an FI mean when it states that its mortgage pool prepayments are assumed to be 100 percent PSA equivalent?
1. Explain precisely the prepayment assumptions of the Public Securities Association prepayment model.
1. What is the difference between the yield spread to average life and the option adjusted spread on mortgage-backed securities?
1. What is the price of the GNMA pass-through with a weighted-average life equal to your solution for part (h) if market yields decline 50 basis points?
1. What is the price of the GNMA pass-through security if its weightedaverage life is equal to your solution for part (h)? Assume no change in market interest rates.
1. If all the mortgages in the pool are completely prepaid at the end of the second month, what is the pool’s weighted-average life? Hint: Use your answer to part (c).
1. What are the expected monthly cash flows for the FI and GNMA?
1. Would actual cash flows to GNMA bondholders deviate from expected cash flows as in part (d)? Why or why not?
1. What is the present value of the GNMA pass-through bonds? Assume that the risk-adjusted market annual rate of return is 8 percent compounded monthly.
1. What are the expected monthly cash flows to GNMA bondholders?
1. For the first two payments, what portion is interest and what portion is principal repayment?
1. What is the present value of the mortgage pool?
1. A FI originates a pool of 500 30-year mortgages, each averaging $150,000 with an annual mortgage coupon rate of 8 percent. Assume that the GNMA credit risk insurance fee is 6 basis points and that the FI’s servicing fee is 19 basis points.
1. If 150 $200,000 mortgages in a $60 million 15-year mortgage pool are expected to be prepaid in three years and the remaining 150 $200,000 mortgages are to be prepaid in four years, what is the weighted-average life of the mortgage pool? Mortgages are fully amortized, with mortgage coupon rates
1. What is the weighted-average life (WAL) of a mortgage pool supporting passthrough securities? How does WAL differ from duration?
1. What are the benefits of market yields that are less than the average rate in the GNMA mortgage pool? What are the disadvantages of this rate inversion? To whom do the good news and the bad news accrue?
1. Under what conditions do mortgage holders have a call option on their mortgages? When is the call option in the money?
1. What is prepayment risk? How does prepayment risk affect the cash flow stream on a fully amortized mortgage loan? What are the two primary factors that cause early payment?
1. Assume that the GNMA is only half amortized. There is a lump-sum payment at the maturity of the GNMA that equals 50 percent of the mortgage pool’s face value.
1. Assume that the GNMA is fully amortized.
1. What would be the impact on GNMA pricing if the pass-through was not fully amortized? What is the present value of a $10 million pool of 15-year mortgages with an 8.5 percent per annum monthly mortgage coupon if market rates are 5 percent? The GNMA guarantee fee is 6 basis points, and the FI
1. Calculate the value of (a) the mortgage pool and (b) the GNMA pass-through in question 11 if market interest rates increase 50 basis points. Assume no prepayments.
1. Calculate the first monthly insurance fee paid to GNMA.
1. Calculate the first monthly servicing fee paid to the originating FIs.
1. What is the monthly payment on the GNMA in part (b)?
1. If the GNMA insurance fee is 6 basis points and the servicing fee is 44 basis points, what is the yield on the GNMA pass-through?
1. What is the monthly mortgage payment (100 percent amortizing) on the pool of mortgages?
1. Consider a GNMA mortgage pool with principal of $20 million. The maturity is 30 years with a monthly mortgage payment of 10 percent per annum.Assume no prepayments.
1. Consider the mortgage pass-through example presented in Table 27–3 . The total monthly payment by the borrowers reflecting a 12 percent mortgage rate is $1,028,610. The payment passed through to the ultimate investors reflecting an 11.5 percent return is $990,291. Who receives the difference
1. What specific changes occur on the balance sheet at the completion of the securitization process? What adjustments occur to the risk profile of the FI?
1. How are investors in pass-through bonds protected against default risk emanating from the mortgagees and the FI/trustee?
1. What advantages does securitization have in dealing with the FI’s risk exposure problems?
1. What are some possible solutions to the duration mismatch and the illiquidity problems?
1. What additional risk exposure problems does the FI face?
1. How does this balance sheet differ from Table 27–1 ? Why?Consider the FI in problem 6.
1. Show a simple balance sheet with total assets, total liabilities, and equity if this is the only project funded by the bank.
1. assuming there is a 10 percent average reserve requirement on demand deposits?
1. What is the minimum amount of demand deposits needed to fund this loan
1. What is the minimum amount of capital required by the Basel accord?
1. An FI is planning to issue $100 million in BB-rated commercial loans. The FI will finance the loans by issuing demand deposits.
1. does securitization reduce the levels of taxation?
1. What three levels of regulatory taxes do FIs face when making loans? How
1. How does FHLMC differ from FNMA? How are they the same?
1. How does FNMA differ from GNMA?
1. What are the primary functions of GNMA? What is timing insurance?
1. What has been the effect of securitization on the asset portfolios of financial institutions?
1. Can all assets and loans be securitized? Explain your answer.
1. To which investors or investor segments is the IO attractive? To which investors or investor segments is the PO attractive? Explain your answer.
1. Would an FI with DA < kDL be interested in buying an IO strip for hedging purposes?
1. Would an AAA FI ever issue mortgage-backed bonds? Explain your answer.
1. on class A bonds. Under what term structure conditions might this not be the case?
1. In our example, the coupon on the class C bonds was assumed to be higher than that on the class B bonds and the coupon on class B bonds was assumed to be higher than that
1. Would thrifts or insurance companies prefer Z-class CMOs? Explain your answer.Are Z-class CMOs exactly the same as T-bond strips? If not, why not?
1. Why did Fannie Mae and Freddie Mac come under fire from regulators in the early 2000s?
1. In the context of the option model approach, list three ways in which transaction and other contracting costs are likely to interfere with the accuracy of its predictions regarding the fair price or interest spread on a pass-through security
1. In general terms, discuss the three approaches developed by analysts to model prepayment behavior.
1. Should an FI with D A < kD L seek to securitize its assets? Why or why not?
1. What two factors can cause prepayments on the mortgages underlying pass-through securities?
1. What are the two sources of cash flows on a pass-through security?
1. Should an FI with DA > kD L seek to securitize its assets? Why or why not?
1. What is a pass-through security?
1. Go to the Federal Reserve Board’s Web site at www.federalreserve.gov . Find the latest data on domestic bank assets held in foreign countries using the following steps. Click on “Economic Research and Data.” From there click on “Statistics: Releases and Historical Data” and then click
1. Go to the FDIC Web site at www.fdic.gov . Find the most recent data on bank asset concentration by size using the following steps. Click on “Analysts.”From there click on “FDIC Quarterly Banking Profile” and then click on“Quarterly Banking Profile.” Click on “Commercial Bank
1. Go to the FDIC Web site at www.fdic.gov. Find the most recent breakdown of bank holding company deposit share for the State of New York using the following steps. Click on “Analysts.” From there click on “Summary of Deposits” and then click on “Deposit Market Share—Pro Forma HHI
1. Go to the Standard & Poor’s Market Insight Web site at www.mhhe.com/edumarketinsight. Click on “Educational Version of Market Insight.” Enter your site ID and click on “Login.” Click on “Company.” Find the most recent data for deposits, equity, and assets held by the Bank of New
1. What are the difficulties of expanding globally? How can each of these difficulties create negative effects on the operating performance of FIs?
1. What are the major advantages of international expansion to FIs? Explain how each advantage can affect the operating performance of FIs.
1. What were the main features of FBSEA? How did FBSEA encourage cooperation with the home country regulator? What was the effect of the FBSEA on the Federal Reserve and on foreign banks?
1. Act (FBSEA) of 1991? What was the main objective of this legislation?
1. What events led to the passage of the Foreign Bank Supervision Enhancement
1. What was the likely effect of the IBA on the growth of foreign bank activities in the United States? Why?
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