MBS Pricing and Analytics

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Course Features

  • Course date:08/21/2019
  • Course Duration: 1 Day
  • Level: Intermediate
  • Prerequisites: None
  • Method: Live & Virtual
  • Venue: MicroTek
  • Time: 9:00 am – 5:00 pm
  • Dress Code: Business Casual
  • Category:
  • Certificate: Yes
  • CPE Credits: 7
  • Course Code: 803

MBS Pricing and Analytics

This one-day program will cover the bond math of MBS and a number of analytic tools and techniques used to evaluate the relative value and risk of the securities. It will cover single family residential mortgage securitizations (agency and non-agency) as they account for a great majority of MBS, though there will be some commentary directed towards CMBS and agency multi-family issues.

MBS PRICE AND YIELD CONVENTIONS

Bond and MBS Price/Yield Formulas

  • Bond: price = present value of coupon and principal payments to maturity
  • Bond: contractual cash flow discount by yield to maturity as periodic rate
  • MBS: price equated to cash flows projected at some PSA or CPR speed
  • Period cash flows: amortized and prepaid principal + pass through interest

MBS Yields

  • Cash flow yield: monthly rate that equates present value to price x 12
  • Bond equivalent yield of MBS

Interpretation of MBS Yields

  • Yield (cash flow, bond equivalent or to maturity) versus rate of return
  • Yield (cash flow and others): price re-expressed as a single interest rate

 

PROJECTING MBS CASH FLOWS AND QUANTIFYING PREPAYMENTS

Mortgage Loan Payment Calculation

  • Calculating monthly payment given size, term and loan interest rate
  • Apportioning the monthly payments between interest and principal
  • Impact of partial prepayments

Projecting Cash Flows for Relating Price to Yield

  • PSA and CPR most widely used though there are others
  • Single monthly mortality (SMM)
  • SMM x outstanding principal = prepaid principal
  • Prepayment benchmark versus prepayment models
  • Cash flow usually projected using a single PSA or CPR speed
  • Schedule of CPRs sometimes used (especially to new issues)

PSA (Public Securities Association/Prepayment Speed Assumptions) Benchmark

  • 30 month long ramp of rising CPRs, constant CPR beyond
  • PSA standard (100% PSA) ramp speeds increasing 2%/month to 6%
  • Other PSA speeds expresses as multiple of CPR
  • PSA profile implications: seasoning for first 30 months, seasoned beyond
  • Market views on and implications of seasoning and seasoned MBS

CPR (Constant or Conditional Prepayment Rate) Benchmark

  • SMM = 1 – (1-CPR)1/12
  • PSA speed must be converted to implied CPR to calculate SMM

Calculating Actual Prepayment Rate

  • Actual monthly mortality ÷ outstanding principal = SMMAct
  • CPRAct = 1 – (1 – SMMAct)12
  • PSAAct = CPRAct ÷ CPR value at PSA standard for that month

Illustration of Cash Flow Projection

 

OPTION-ADJUSTED SPREAD ANALYSIS

Evaluation of Spread Between Treasury and MBS Spot Rate Curves

  • Reason for using spread between curves rather than security yields
  • Higher MBS rates and lower cost per dollar of future cash flows
  • OAS analysis: solve for portion due to more liquidity and credit risk
  • Remainder due to premium for selling option

Calculation of Z (Zero Volatility) or Static Spread

  • Project cash flows at vector of prepayment rates
  • Rates based on forward interest rates and prepayment model
  • Solve for constant spread to Treasury spot rates so price = PV

OAS of MBS Uses Monte Carlo Simulation

  • Project numerous (100-300) interest rate paths
  • Assume some volatility and appropriate rules (e.g. mean reversion)
  • Random generation of monthly risk-free rates
  • Use to generate mortgage rates, in turn used to obtain cash flows
  • OAS based on spread to projected rates the equate average PV to price

Cost of Option = Z Spread – OAS

Analytic Applications of OAS Analysis

 

DURATION AND CONVEXITY OF RMBS

Duration

  • Development of Duration
  • Types of duration: Macaulay, modified, effective and dollar
  • Duration as a measure of bond/portfolio values sensitivity to interest rates

Duration and Convexity of Non-callable Bonds

  • Positive convexity
  • Modified duration determination and interpretation

Duration of MBS

  • Effective or OAS duration
  • Other methodologies for estimating sensitivity of MBS to yield changes

Applications of Duration

  • Evaluation of the relative value and risk of different bonds
  • Structuring bond position hedges
  • Active portfolio management – adjusting duration versus benchmark index

Convexity of MBS

  • Negative convexity due to prepayment risk
  • Negative convexity for yield below and a bit above pass-through rate
  • Positive convexity at yield well above pass-through rate

Factors Impacting Negative Convexity

  • Tied to value of prepayment option
  • Implication of greater or lesser negative convexity
  • Factors impacting: loan size, cost of refinancing, underwater loans, etc.

Instructor

  • John Donato has a broad range of experience in the financial industry, including trading, brokering, and designing many aspects of real-time fixed income and foreign exchange trading systems for interdealer markets. John began his career with trading and risk management roles in fixed income and foreign exchange markets with commercial banks in New York. Among …
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