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The MZ Mortgage Company is issuing a CMO with three tranches. The A tranche will consist...

The MZ Mortgage Company is issuing a CMO with three tranches. The A tranche will consist of $40.5 milliion with a coupon of 8.25 percent. The B tranche will be issued with a coupon of 9.0 percent and a principal of $22.5 million. The Z tranche will carry a coupon of 10.0 perecent with a principal of $45 million. The mortgages backing the security issue were originated at a fixed rate of 10 percent with a maturity of 10 years (annual payments). The issue will be overcollateralized by $4.5 million, and he issuer will receive all net cash flows after priority payments are made toeach class of securities. Priority payments wll be made to the class A tranche and will include the promised coupon, all amortization from the mortage pool, and interest that will be accrued to the Z class until the principal of $40.5 million due to the A tranche is repaid. The B class securities will receive intereest only payments until the A class is repaid, and then will receive priority payments of amortization and accrued interest. The Z class will accrue interest at 10 perecent until both A and B classes are repaid. It will receive current interest and principal payments at that time.

e. What are the residual cash flows to MZ? What rate of return will be earned on the equity overcollateralization?

f. Assume that the mortgages in the underlying pool prepay at the rate of 10 percent per year. How will your answers in e change?

g. Assume that immediately after the securities are issued in case (f) the price of all securities suddenly trades up by 10 percent over the issue price. What will the yield to maturity be for each security?

Solutions

Expert Solution

(e)

Residual Class

Total

Other

Year

in pool

Classes

Residual

0

($4,500.00)

1

$18,308.86

$16,925.11

1,383.75

2

$18,308.86

17,127.39

1,181.47

3

$18,308.86

17,349.89

958.96

4

$18,308.86

17,594.65

714.20

5

$18,308.86

17,765.30

543.55

6

$18,308.86

17,858.86

450.00

7

$18,308.86

17,858.86

450.00

8

$18,308.86

17,858.86

450.00

9

$18,308.86

17,858.86

450.00

10

$18,308.86

13,358.86

4,950.00

IRR

19.10%

(f)

Assuming 10% prepayment

Mortgage Pool

Year

Beg. Bal

Payment

Interest

Principal

End Bal

Prepayment

1

$112,500.00

$18,308.86

11,250.00

$18,308.86

$94,191.14

11250.00

2

94,191.14

$16,355.40

9,419.11

$16,355.40

$77,835.74

9419.11

3

77,835.74

$14,589.84

7,783.57

$14,589.84

$63,245.90

7783.57

4

63,245.90

$12,991.06

6,324.59

$12,991.06

$50,254.84

6324.59

5

50,254.84

$11,538.88

5,025.48

$11,538.88

$38,715.96

5025.48

6

38,715.96

$10,213.17

3,871.60

$10,213.17

$28,502.79

3871.60

7

28,502.79

$8,991.80

2,850.28

$8,991.80

$19,510.99

2850.28

8

19,510.99

$7,845.66

1,951.10

$7,845.66

$11,665.33

1951.10

9

11,665.33

$6,721.45

1,166.53

$6,721.45

$4,943.88

1166.53

10

4,943.88

$5,438.27

494.39

$4,943.88

$0.00

494.39

Tranche A

Cash

Year

Beg. Bal

Interest

Principal

End Bal

Flow

1

$40,500.00

3,341.25

$22,808.86

$17,691.14

26,150.11

2

17,691.14

1,459.52

17,691.14

0.00

19,150.66

3

0.00

0.00

0.00

0.00

0.00

4

0.00

0.00

0.00

0.00

0.00

5

0.00

0.00

0.00

0.00

0.00

6

0.00

0.00

0.00

0.00

0.00

7

0.00

0.00

0.00

0.00

0.00

8

0.00

0.00

0.00

0.00

0.00

9

0.00

0.00

0.00

0.00

0.00

10

0.00

0.00

0.00

0.00

0.00

P V at

8.50%

$40,369

Tranche B

Cash

Year

Beg. Bal

Interest

Principal

End Bal

Flow

1

$22,500.00

$2,025.00

$0.00

$22,500.00

2,025.00

2

22,500.00

2,025.00

3,614.26

18,885.74

5,639.26

3

18,885.74

1,699.72

18,885.74

0.00

20,585.46

4

0.00

0.00

0.00

0.00

0.00

5

0.00

0.00

0.00

0.00

0.00

6

0.00

0.00

0.00

0.00

0.00

7

0.00

0.00

0.00

0.00

0.00

8

0.00

0.00

0.00

0.00

0.00

9

0.00

0.00

0.00

0.00

0.00

10

0.00

0.00

0.00

0.00

0.00

P V at

9.50%

$22,232

Tranche Z

Total

Cash

Year

Beg. Bal

Interest

Payment

End Bal

Flow

0

($45,000)

1

$45,000.00

4,500.00

0.00

$49,500.00

0.00

2

49,500.00

4,950.00

0.00

54,450.00

0.00

3

54,450.00

5,445.00

1,149.10

58,745.90

1,149.10

4

58,745.90

5,874.59

18,865.65

45,754.84

18,865.65

5

45,754.84

4,575.48

16,114.37

34,215.96

16,114.37

6

34,215.96

3,421.60

13,634.77

24,002.79

13,634.77

7

24,002.79

2,400.28

11,392.08

15,010.99

11,392.08

8

15,010.99

1,501.10

9,346.76

7,165.33

9,346.76

9

7,165.33

716.53

7,437.99

443.88

7,437.99

10

443.88

44.39

488.27

0.00

488.27

IRR

10.00%

P V at

9.75%

$45,588

Residual

Total

Other

Year

in pool

Classes

Residual

0

($4,500.00)

1

$29,558.86

$28,175.11

1,383.75

2

$25,774.52

24,789.92

984.60

3

$22,373.42

21,734.56

638.86

4

$19,315.65

18,865.65

450.00

5

$16,564.37

16,114.37

450.00

6

$14,084.77

13,634.77

450.00

7

$11,842.08

11,392.08

450.00

8

$9,796.76

9,346.76

450.00

9

$7,887.99

7,437.99

450.00

10

$5,438.27

488.27

4,950.00

IRR

16.10%

(g)

10 percent price increase after issue

Tranche A

Cash

Year

Beg. Bal

Interest

Principal

End Bal

Flow

10% Price Increase

0

($44,550)

1

$40,500.00

3,341.25

$22,808.86

$17,691.14

26,150.11

26,150.11

2

17,691.14

1,459.52

17,691.14

0.00

19,150.66

19,150.66

3

0.00

0.00

0.00

0.00

0.00

0.00

4

0.00

0.00

0.00

0.00

0.00

0.00

5

0.00

0.00

0.00

0.00

0.00

0.00

6

0.00

0.00

0.00

0.00

0.00

0.00

7

0.00

0.00

0.00

0.00

0.00

0.00

8

0.00

0.00

0.00

0.00

0.00

0.00

9

0.00

0.00

0.00

0.00

0.00

0.00

10

0.00

0.00

0.00

0.00

0.00

0.00

P V at

8.50%

$40,369

YTM

1.18%


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