Now, suppose than instead the CMO was structured as a sequential pay security. T
ID: 2723778 • Letter: N
Question
Now, suppose than instead the CMO was structured as a sequential pay security. There is $20,000,000 of principal allotted to the A Tranche, which has a coupon rate of 3.75%, $30,000,000 of principal allotted to the B Tranche, which has a coupon rate of 4.25%, $45,000,000 of principal allotted to the Z (accrual) Tranche, which has a coupon rate of 5%. The issuer (residual) will receive cash flows after payment rules to other classes are satisfied.
The payment rules are as follows:
Priority payments will be made to the A tranche and the A class will be first to receive their promised coupon payment. The B class will receive interest payments only until the A class is repaid. In addition to interest, A will receive priority payments toward principal in the amount of sum of principal repayment by the pool and the interest accrued to Z in that period. After A is repaid, B then will receive priority payments of amortization and accrued interest according the same rules as A. The Z class will accrue interest until both A and B are repaid. Z will receive current interest and principal payments at that time according to the same rules as A and B. All cash flows from the pool that are not designated by the above rules will go to the residual class in that period.
A. what is IRR to the residual?
B.If instead the payment rules were such that the issuer (residual) will receive cash flows only after all classes of investors have been completely repaid. and you were told that the Z class began year 10 with an outstanding balance of $8,000,000 and the CMO generated cash flows consistent with the cash flows presented under the 0 prepayment scenario, what would be the IRR to the residual class?
Cash Flows to the Residual
Time CF
0?
1?
2 473,497
3 338,433
4 250,000
5 250,000
6 250,000
7 250,000
8 250,000
9 1,684,293
10 3,743,992
Explanation / Answer
IRR = PV Factor = Initial investment / Average Cash inflow
Total Cash inflow = 7,490,215
Average inflow = 7,490,215/ 9 = 832,246
Initial investment of tranche A = $20,000,000
Tranche A PV Factor = $ 20,000,000/ $ 832,246 = 24
The PV factor of 27 is to be located in the annuity Table
This falls in the 30%
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.