1. A CMO is issued with three tranches. The A tranche will consist of $300 million with a coupon of 3%. The B tranche will be issued with a coupon of 3.5% and a principal of $100 million. The Z-tranche will carry a coupon of 4% with a principal of $50 million. The mortgages backing the security are originated at a fixed rate of 4.5% with a maturity of 5 years (annual payments). The issue will be overcollateralized by $50 million. The issuer will receive all net cash flows after priority payments are made to each class of securities. The Z tranche will accrue interest at 4% until Tranche A and B are repaid.

a.	Find the price of Tranche A if market interest rates were 2.75%, assuming the mortgages in the underlying pool prepay at an annual rate of 10% (based on the amortized pool balance at the end of the year).
b.	If Tranche B investors demand 3% yield to maturity, what would be the price of the Tranche B security, assuming the mortgages in the underlying pool prepay at an annual rate of 10% (based on the amortized pool balance at the end of the year)?
c.	Find the price of the Z Tranche if investors demand a 3.5% yield to maturity, assuming the mortgages in the underlying pool prepay at an annual rate of 10% (based on the amortized pool balance at the end of the year).
d.	Find the value of the residual tranche if market interest rates were 8%, assuming a 10% constant rate of prepayment (based on the amortized pool balance at the end of the year).
e.	Is there an arbitrage profit earned by selling this CMO? That is, is the sum of the individual parts worth more than the whole? If so, what is the arbitrage profit?
f.	What is the major difference between a CMO and a MBS and how can this difference attract a broader class of investors and lead to arbitrage opportunities?