**mortgage loans**

**(a)** __Electronic copies__ of your solutions are due at **gmwelke@cpp.edu** by **11:59pm Friday, Dec 14**. Late copes will NOT be accepted; I will reply within 24hrs of receiving it, SO CHECK BACK to make sure I could open your file etc. (no reply from me means I never even got it), or run the risk of getting zero. Email one copy, __cc group members__.

**(b) **Work in groups of __three__. Email me your **group composition by end-of-the day, Tuesday Dec 4**. You may not be in a group with someone that was with you on your mid-term project group. Send only one email, __cc the other two group members__. You will be penalized 3 points on this project if I have to assign you to a group. If you’ve already received at confirmation from me, you’re set.

**(c)** You must also email me, by the due date/time, a grade of your fellow group members’ contribution to the project. Score it out of 10, based on contribution to the CMO construction and in answering questions, participation in meetings and discussions, etc. __You __*must*__ justify (explain) your grade, especially if giving less than 10/10__. Your grade will contribute up to 5 points to the member’s project grade, though the “gradee” will not know what his/her fellow members’ assessment. If you do not email me the evaluation of your teammates, you will be penalized 5 points *and* your teammates’ assessment of you will be set to 0. __Do NOT cc other group members.__

**(d)** Thus, the total possible points for the project are 35 = 30 for project (see below) + 5 from your team’s assessment of your contribution.

**(e)** The name of the file you mail me should be* “[last name1]_[last name2]_[last_name3]_3832-Final”*. If the group’s identity is not apparent from the file name, the project will be penalized 3 points. Also make sure your document is reasonably ready to print (the waterfall sheet will be too wide, though), and include group member full names in the file.

**(f)** I **very** strongly prefer excel, but other formats are permissible __ if__ accompanied by a pdf printout of your solutions (or a hard copy at the RE department by the same deadline). Note that I am not currently set up to open any spreadsheet but excel. Also: the more you explain what you do, the likelier you’ll get more partial credit. I’m unlikely to spend too much time trying to figure out where you went wrong. You do not need to annotate cells (since I will be looking at them), but pay attention to the logical structure and presentation of the worksheets. SEND ONLY ONE FILE (e.g. excel) that includes your answers to the questions (use textbox, for example;

**(g)** Work with members of your own group only. You may use any source you find useful, *except *the help of another person outside your group. The latter constitutes “cheating,” and will very likely result, at a minimum, in an F for the class. In particular, *do not* try to abuse my typing finger by requesting answers to “non-clarifying questions” by email. I will be arranging extra office hours for the exams week.

**Final Project [30 points total]**

**A. [20 points total]** Consider the second last (12.7+ million) and last (76.7+ million) “mortgage loans” in loan group 1 in the Countrywide Alternative Trust 2005-J7 (p S-69).

**1.** Amortize both loans with a 100% PPC assumption as given on p. S-70, and a 100% SDA (this is now the base PP/D assumption; leave the factors open to change).[1] To simplify, assume that any default is realized instantaneously and that there is no recovery.[2] Also make the standard assumption that default happens before mortgage payment, prepayment after.

**2.** Create a WAC IO and PO tranche to give a 5.75% deal coupon. Assume that these two classes are paid first (before subs and seniors – see below). The WAC PO gets the aggregate (initial PO%) × (total principal cash flow), the WAC IO the aggregate excess interest on outstanding, current premium loan balance.[3]

**3.** With the remaining assets, create a senior/sub structure with 5% subordination, and a shifting interest structure as given on p S-61, under “shift percentage.” Take a percentage of, for example, 60% to mean that the sub receives only 60% of its prorated __prepay__ principal (provided the sub still exists). The sub will be a single class (called “B”) that absorbs all realized losses first. Once the sub is exhausted, all seniors (see below) are allocated losses on a prorated basis. Assume interest is paid to the aggregate senior classes at 5.75% and any remaining interest is distributed to the sub.

**4.** Use the senior class to create a sequential pay structure of two classes, with principal A1:A2 :: 3:1. Prorate potential senior losses to A1 and A2 based on pre-default principal; assign each class its interest payment prorated on post-default beginning balance.

**5.** Assume all classes sold under the base PP/D assumption at: A-1: 102:01; A-2: 99:20; B: 75:04; IO: 0:20 (notional); PO: 81:31. The notation “:nn” means “nn/32nds.”

**6.** Assume a Treasury term structure given by

*z(T) = 0.03 × ln[0.038 × (T+40)]*

where *T* is measured in months.

**7.** Make reasonable assumptions for any missing information, and justify them. Take care that you may only think the information to be missing.

**B. [10 points total]** Answer the following questions (on a separate worksheet within your workbook)

- [2] What is the initial principal and cash flow yield for each class? Compare the total price of the tranches to the principal value. Generally, why does the total market value of the deal exceed the initial pool balance?
- [2] Compute the WAL, modified duration, and convexity for each tranche at base PPC/default. For simplicity, assume that a small
*Δ**y*does not affect the effective prepayment speed. - [2] Compute the nominal- and Z-spread for each tranche. Does a positive spread automatically mean that the tranche is a better investment than a Treasury?
- [2] Keeping the SDA fixed at its baseline value, plot the WAL of each principal-paying tranche vs the PPC (in the range 0 to 300%).
- [2] Plot the cash flow yield of each tranche vs the SDA percentage, in the range 0 to 800%, for a PPC of 100%.

[1] Note that these loans are Alt-A, and their default behavior is different from prime mortgages. Nonetheless, we use SDA to simplify the discussion.

[2] A gross simplification.

[3]This means that the IO and PO trance are effectively sharing in losses with trance B (see next), which is uncommon. More typically they are senior tranches.

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