Question

In: Finance

Consider an MPT with WAC=5% with par value of $5,000,000. There is a servicing fee of...

Consider an MPT with WAC=5% with par value of $5,000,000. There is a servicing fee of 0.4% a year for this security. Mark all statements that are true:

If market rate is 5%, the MPT will sell at $5,000,000

If market rate is 7%, higher projected prepayment rates will result in higher valuation for the MPT

If market rate is 4.6%, the MPT will sell at $5,000,000

If market rate is 4.6%, higher projected prepayment rates will result in higher valuation for the MPT

If market rate is 7%, the MPT will sell above par value

Solutions

Expert Solution

Discount rate

5%

7%

4.60%

4.60%

7%

Service charge =0.4%

Present value =Par value/(1+discount rate)

5000000/(1.05)

5000000/(1.07)

5000000/(1.046)

5000000/(1.046)

5000000/(1.07)

Par Value=

5000000

4761904.762

4672897.196

4780114.723

4780114.723

4672897.196

Service charge =0.4%

47619004.76*0.04

4672897.196*0.04

4780114.723*0.04

4780114.723*0.04

4672897.196*0.04

1904760.19

186915.8878

191204.5889

191204.5889

186915.8878

Final amount =PV - service charge

4571428.572

4485981.308

4588910.134

4588910.134

4485981.308

As we know that the price of bond is inversely proportion to its yield or discount rate.

Scenario 1: If the market rate is 5%. ideally if the market rate is same as discount rate the MPT should sell at 5000000 but since there is a service fee, it will sell at a lower price than 5000000. So this scenario is false

Scenario 2: If the market rate is 7% higher projected prepayment rates will result in higher value of the MPT

If the market rate is 7% the MPT should sell at a price lower than 5000000. Since the investor could get a better rate (7%) at market than buying the MPT (5%). The MPT seller has to lower the price of the MPT. So this scenario is false

Scenario 3: If the market rate is 4.6% the MPT will sell at 5000000

If the market rate is 4.6% the MPT should sell at a price higher than 5000000. Since the investor could get a better rate buy buying the MPT (5%) then investing in the market. So this scenario is true.

Scenario 4: If the market rate is 4.6% higher projected prepayment rates will result in higher value of the MPT

If we consider the scenario 3, this scenario will be false.

Scenario 5: If the market rate is 7% the MPT will sell above the par value of 5000000

If we consider the scenario 2, this scenario will be false.


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