Problem 6 [15 points] CMO security offering with sequential annual pay tranches coupon rate amount issued Mortgage pool CMO classes Mortgages $100,000,000 Class A Bonds 3.00% $30,000,000 6% interest rate Class B Bonds 4.25% $30,000,000 10 year maturity Class Z Bonds 5.50% $30,000,000 Total bonds $90,000,000 Total assets $100,000,000 Equity contribution by issuer $10,000,000 Total debt and equity $100,000,000 Rules of cash distributions to A, B and Z: interest is paid currently on tranches A and B, but it is not paid on tranche Z until principal on the other tranches is repaid. For tranche Z interest will be accrued and accumulated into the investment balance. In addition, to ensure that the maturity of tranche A securities is kept relatively short, the interest accrued to tranche Z and all current principal and prepayments from the entire mortgage pool will be allocated to tranche A, and then to tranche B. Questions 1. [7 points] Suppose that there are no prepayment and no default, what are the cash flows for Class A, Class B and Class Z bonds? What is the IRR for the issuer? 2. [8 points] Suppose that there are 15% prepayment and no default, what are the cash flows for Class A, Class B and Class Z bonds? What is the IRR for the issuer? cBook Air