BFW 2401

Week 11 tutorial questions

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1. A bank has made a three-year $10 million loan that pays annual interest of 8 per cent. The
principal is due at the end of the third year.

(a) The bank is willing to sell this loan with recourse at an interest rate of 8.5 per cent. What
price should it receive for this loan?
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(b) The bank has the option to sell this loan without recourse at a discount rate of 8.75 per cent.
What price should it receive for this loan?
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(c) If the bank expects a 0.5 per cent probability of default on this loan, is it better to sell this loan
with or without recourse? It expects to receive no interest payments or principal if the loan is
defaulted.
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(d) Explain how the sale of the loan with recourse will change the duration characteristics of the
balance sheet.
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2. Why are yields higher on loan sales than on commercial paper issues with similar maturity and
issue size?
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3. Consider a mortgage pool with principal of $20 million. The maturity is 30 years with a
monthly mortgage payment of 10 per cent per annum. (Assume no prepayments.) Formatted: Font: Bold

(a) What is the monthly mortgage payment (100 per cent amortising) on the pool of mortgages?

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(b) If the mortgage backed security insurance fee is 6 basis points and the servicing fee is 44 basis Formatted: Font: Bold
points, what is the yield on the pass-through security? Formatted: Font: Bold
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(c) What is the monthly payment on the pass-through security in part (b)?
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(d) Calculate the first monthly servicing fee paid to the originating banks.
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5. What factors affect prepayment probability? Formatted: Font: Bold

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6. Consider $200 million of 30-year mortgages with a coupon of 10 per cent p.a. paid quarterly. Formatted: Font: Bold
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(a) What is the quarterly mortgage payment?
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(b) What are the interest repayments over the first year of life of the mortgages? What are the Formatted: Font: Bold
principal repayments?
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7. Using the information given in problem 6 above, assume now you construct a 30-year CMO using Formatted: Font: Bold
this mortgage pool as collateral. There are three tranches (where A offers the least protection
against prepayment and C offers the most). A $50 million Tranche A makes quarterly payments of
9 per cent p.a.; a $100 million Tranche B makes quarterly payments of 10 per cent; and a $50
million Tranche C makes quarterly payments of 11 per cent.
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(i) Assume non-amortisation of principal and no prepayments. What are the total promised
coupon payments to the three classes? What are the principal payments to each of the three classes for
the first year? (Hint: calculate the payment for tranche “A” first)
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(ii) If, over the first year, the trustee receives quarterly prepayments of $10 million on the
mortgage pool, how are the funds distributed?
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(iii) How are the cash flows distributed if in the first half of the second year prepayments are $20
million quarterly?
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(iv) How can the CMO-issuer earn a positive spread on the CMO?

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8. How does securitisation impact on the FI's role as a delegated monitor? Formatted: Font: Bold
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9. How does the FI use securitisation to manage its risk exposure? (Be sure to consider interest
rate, currency, liquidity and credit risks.)
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