Suppose XYZ Bank Ltd has made 300 identical mortgage loans today. Each loan is for $350,000 to be repaid each month over the next 30 years. The interest rate on each loan is 7.5% per annum nominal. (a) Calculate the expected monthly cash flows to the bank from this mortgage pool and the principal amount owing to the bank at the end of five years. Assume no prepayments in your calculation. (b) Carefully describe the risks to the bank from making this pool of loans. (c) Suppose XYZ Bank Ltd has decided to issue a series of mortgage backed securities to pass on these risks. They issue 100 CMO contracts. Your manager is a bond fund manager and asks you, an analyst, to write down the advantages and disadvantages of investing in these CMO contracts. Writedown your response.
Question 7
Suppose XYZ Bank Ltd has made 300 identical mortgage loans today. Each loan is for $350,000 to be repaid each month over the next 30 years. The interest rate on each loan is 7.5% per annum nominal.
(a) Calculate the expected monthly cash flows to the bank from this mortgage pool and the principal amount owing to the bank at the end of five years. Assume no prepayments in your calculation.
(b) Carefully describe the risks to the bank from making this pool of loans.
(c) Suppose XYZ Bank Ltd has decided to issue a series of mortgage backed securities to pass on these risks. They issue 100 CMO contracts. Your manager is a bond fund manager and asks you, an analyst, to write down the advantages and disadvantages of investing in these CMO contracts. Writedown your response.
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