Please answer all questions clearly and show all calculation.

Question 2

The Super Fund owns the following two 30-year original maturity mortgage-backed securities shown in the table below. The fund uses the 10-year US Treasury yield as a relative measure to gauge the level of current 30-year home mortgage rates. Over the past four years, the 10-year US Treasury yield has declined below 5.50% three times, subsequently rising above 6.50 % each time. The 10-year US treasury yield is currently at 6.50%.

Weighted Average Current Month

Issue Coupon Maturity (months) Price CPR

MBS-1 7.50% 355 100 5

MBS-2 7.50% 260 100 12

(a) Analyse the effect on prepayments of each of the following three factors:

(i) coupon rate of the mortgage

(ii) age of the mortgage

(iii) seasonality

(b) Describe how principal prepayment risks is measured. Based on the table above which security will experience a higher percentage of principal prepayment?

(c) Appraise the reasons why prepayments are likely to be more stable for automobile receivables asset-backed securities when compared to similar-duration mortgage-backed securities.