An issuer is trying to structure a floating rate tranche in a CMO offering. The
ID: 2726951 • Letter: A
Question
An issuer is trying to structure a floating rate tranche in a CMO offering. The tranche will be backed by mortgages with 8% interest rate and current balance of $2000000. Interest payable to investors in the floating rate securities (F) and investors floater securities (IF) will be based on an initial, or base, market rate of 8%. Investors in the F portion of the tranche will be benefit to the extent of any increases from the base rate of interest and (IF) investors extent of any will benefit to the extent of any decreases from the bas rate. a) Assuming that F and IF portions of the tranche are equal (50% each) what will the share of interest be for each class of investors of the day of issue? A maximum cap must be set on increases in the base rate of interest for the F investors. What would such a cap be? What would be the floor for the IF portion of offering? b) Assume IF buyers prefer a levearaged offering. If the terms in (a) were altered to a ratio of 60% to F investors, what would the interest allocation be on the day of the issue? What would the cap and floor be? c) Compare the terms in (a) and (b). Assume now that a 2% increase from the base rate of 8% occurs immediately after CMO offering. What happens to the cash distributions to the F and IF investors? Assume that a 2% decrease from the base rate occurs. What happens to the cash distributions? Which class of investors experiences more volatility in cash flow and therefore price volatiilty? why?
Explanation / Answer
The MZ Mortgage Company is issuing a CMO with three tranches. The A tranche will consist of $40.5 million with a coupon of 8.25%. The B tranche will be issued with a coupon of 9% and a principal of $22.5 million. The Z tranche will carry a coupon of 10% with a principal of $45 million. The mortgages backing the security issue were originated at a fixed rate of 10% with a maturity of 10 years (annual payments). The issue will be over collarteralized by $4.5 million, and the issuer will receive all net cash flows after priority payments are made to each class of securities. Priority payments will made to the class A tranche and will include the promised coupon, all amortization from the mortgage pool, and interest that will be accrued to the Z class until the principal of $40.5 million due tot he A tranche is repaid. The B class securities will receive interest only payments until the A class is repaid, and then will receive priority payments of amortization and accrued interest. The Z class will accrue interest at 10% untill both A and B classes are repaid. It will receive current interest and principal payments at that time. a. What will be the weighted average coupon on the CMO when issued? b. What will be the maturity of each tranche assuming no prepayment of mortgages in the pool? c. What will be the WAC at the end of year 3? Year 4? Year 8? d. If class A, B, and Z investors demand an 8.5%, 9.5%, and 9.75% yield to maturity, respectively, at the time of issue, what price should MZ Mortgage Company ask for each security? How much will the company receive as proceeds from the CMO issue? e. What are the residual cash flows to MZ? What rate of return will be earned on the equity over collateralization?
a. What will be the weighted average coupon on the CMO when issued?
WAC = Weights X coupon
b. What will be the maturity of each tranche assuming no prepayment of mortgages in the pool?
d. If class A, B, and Z investors demand an 8.5%, 9.5%, and 9.75% yield to maturity, respectively, at the time of issue, what price should MZ Mortgage Company ask for each security?
The MZ Mortgage Company is issuing a CMO with three tranches. The A tranche will consist of $40.5 million with a coupon of 8.25%. The B tranche will be issued with a coupon of 9% and a principal of $22.5 million. The Z tranche will carry a coupon of 10% with a principal of $45 million. The mortgages backing the security issue were originated at a fixed rate of 10% with a maturity of 10 years (annual payments). The issue will be over collarteralized by $4.5 million, and the issuer will receive all net cash flows after priority payments are made to each class of securities. Priority payments will made to the class A tranche and will include the promised coupon, all amortization from the mortgage pool, and interest that will be accrued to the Z class until the principal of $40.5 million due tot he A tranche is repaid. The B class securities will receive interest only payments until the A class is repaid, and then will receive priority payments of amortization and accrued interest. The Z class will accrue interest at 10% untill both A and B classes are repaid. It will receive current interest and principal payments at that time. a. What will be the weighted average coupon on the CMO when issued? b. What will be the maturity of each tranche assuming no prepayment of mortgages in the pool? c. What will be the WAC at the end of year 3? Year 4? Year 8? d. If class A, B, and Z investors demand an 8.5%, 9.5%, and 9.75% yield to maturity, respectively, at the time of issue, what price should MZ Mortgage Company ask for each security? How much will the company receive as proceeds from the CMO issue? e. What are the residual cash flows to MZ? What rate of return will be earned on the equity over collateralization?
Tranche Principal Coupon Rate A $40,500,000 8.25% B $22,500,000 9% Z $45,000,000 10%a. What will be the weighted average coupon on the CMO when issued?
Tranche Principal Weights Coupon RateWAC = Weights X coupon
A $40,500,000 37.50% 8.25% 3.09% B $22,500,000 20.83% 9% 1.88% Z $45,000,000 41.67% 10% 4.17% $108,000,000 Total WAC 9.14%b. What will be the maturity of each tranche assuming no prepayment of mortgages in the pool?
Tranche Principal Coupon Rate Rate PMT(principal X rate Maturity(NPER) A $40,500,000 8.25% 10% $3,341,250.00 8.33 years B $22,500,000 9% 10% $2,025,000.00 7.84 years Z $45,000,000 10% 10% $4,500,000.00 7.27 years c. What will be the WAC at the end of year 3? Year 4? WAC would be 9.14% at the end of year 3,4 and 8d. If class A, B, and Z investors demand an 8.5%, 9.5%, and 9.75% yield to maturity, respectively, at the time of issue, what price should MZ Mortgage Company ask for each security?
Tranche Principal Coupon Rate Rate PMT(principal X rate Maturity(NPER) Yield Present Value A $40,500,000 8.25% 10% $3,341,250.00 8.33 8.50% $39,912,549.23 B $22,500,000 9% 10% $2,025,000.00 7.84 9.50% $21,897,128.42 Z $45,000,000 10% 10% $4,500,000.00 7.27 9.75% $45,567,297.13Related Questions
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