Question

Consider an MPT created from the following pool of loans:

	Number of Loans	Principal	Rate	Maturity
Group 1	50	$200,000	5%	30 years
Group 2	100	$100,000	4%	15 years

Which of the following statements is FALSE?

	A.	At issuance, WAC of this security is 4.5%
	B.	As mortgages in this pool become more seasoned, WAC will go up
	C.	At issuance, WAM of this security is 22.5 years
	D.	As mortgages in this pool become more seasoned, WAM will go up
	E.	At issuance, both groups have equal share in total pool balance

Answer 1

	Number of Loans	Principal	Rate	Maturity
Group 1	50	$ 200,000	5%	30years
Group 2	100	$ 100,000	4%	15 years

Let us first calculate the total pool balance , which is the sum product of the number of loans and principal,

So Group 1 pool balance =50*200,000 = 10,000,000

and Group 2 pool balance = 100*100,000 = 10,000,000

One can see that both groups have equal share in total pool balance, so Option E is clearly true

The WAM and WAC are calculated as follows:-

WAM = Group 1 pool balance* Maturity of Group 1 + Group 2 pool balance /(Total pool balance)

=10,000,000*30+ 10,000,000*15 /(20,000,000) =22.5 years

WAC= Group1 pool balance*Rate + Group 2 pool balance*Rate/(Total pool balance)

=10,000,000*5% + 10,000,000*4%/(20,000,000) = 4.5%

Option A and C are also true as per our calculations.

Seasonng refers to the passage of time associated wth a security while being traded on the market.

So, the maturity of each of the mortgage securities s bound to go down as it will get closer to maturity as the securities get more seasoned. So, WAM falls down due to reduction in maturity.

Option D is false as WAM should go down and not go up.

WAC may remain the same due to seasoning generally unless there are drastic changes to the yield due to convergence.