1. A simple mortgage pool consist of the following two mortages; a $90,000 mortg

Question

1. A simple mortgage pool consist of the following two mortages; a $90,000 mortgage at 6% for 15 years and a $110,000 mortgage at 5% for 30 years. The WAC is ___%, and the WAM is ______ years.

5.50, 22.50

5.45, 23.25

5.45, 22.50

5.00, 30.00

2. The risk that the debtor (the entity that borrowed money) does not repay part or all of its financial obligation is called:

Default risk

Credit spread risk

Downgrade risk

Credit deterioration risk

3. A $100 million deal can be divided into two classes: a $90 million senior class and a $10 million subordinate class. If there is $11 million of losses, what percentage of loss will the senior class realize?

0%

1%

1.11%

2.22%

Explanation / Answer

1) WAC is weighted average coupon

WAC is sum of product of weight of securities and its yield

Total mortgage = $90,000 + $110,000 = $200,000

weight of first security = 90,000 / 200,000 = 0.45

Yield of first security = 6%

weight of secod security = 110,000 / 200,000 = 0.55

Yield of second security = 5%

WAC = (0.45*6) + (0.55*5) = 5.45%

WAM is weighted average maturity

WAM is sum of product of weight of securities and its maturity

Maturity of first security = 15 years

Maturity of second security = 30 years

WAM = (0.45*15) + (0.55*30) = 23.25 years

2) Default risk is the risk associated if a debtor is anot able to part of or all of its financial obligation.

Credit spread is the difference between US treasury bond risk and debt risk. So credit spread is associated with increasing that difference.

Downgrade risk is associated with the debt security credit rating will be downgraded

Credit deterioration risk is associated with deterioration in credit of debtor

So the answer is option 'a'

3) Total value of deal = $100 million

Senior class share = $90 million

Subordinate class share = $10 million

In case of senior subordinate structuring all the losses first absorbed by subordinate class and then it will move to senior class.

In this case total loss = $11 million

These losses first absorbed by subordinate class, subordinate class will be able to absorb = $10 million

So loss move to senior class = Total loss - loss absorbed by subordinate class = 11-10 = $1 million

So percentage of losses realized by senior class = Loss realized by senior class / senior class share = 1/90 = 1.11%

So the answer is option 'c' i.e. 1.11%

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