Reading 57: Valuing Mortgage-Backed and Asset-Backed Securit 2010, security, center, style, label

土豆妮

Session 15: Fixed Income: Structured Securities
Reading 57: Valuing Mortgage-Backed and Asset-Backed Securities

LOS a, (Part 2): Illustrate the computation, use, and limitations of the nominal spread and zero-volatility spread for a mortgage-backed security (MBS) and an asset-backed security (ABS).

 

 

 

The difference between the cash flow yield on a mortgage-backed security (MBS) and the yield on a Treasury with a maturity equal to the average life of the MBS is called the:

A) nominal spread.

B) zero-volatility spread.

C) Z-spread.

---

 

The difference between the cash flow yield on an MBS and the yield on a Treasury with a maturity equal to the average life of the MBS is called the nominal spread.

土豆妮

Which of the following is a limitation of the nominal spread for a mortgage-backed security? The nominal spread:

A) is not adjusted for interest rate risk.

B) does not account for the fact that mortgage-backed securities have higher convexity than Treasuries.

C) is not adjusted for prepayment risk.

---

The nominal spread masks the fact that a portion of it is solely compensation for accepting the prepayment risk of the MBS.

土豆妮

Which of the following is a limitation of the zero-volatility spread for a mortgage-backed security (MBS)? The zero-volatility spread:

A) does not account for the fact that MBSs have higher convexity than Treasuries.

B) is not adjusted for prepayment risk.

C) is not adjusted for interest rate risk.

---

The zero-volatility spread (also known as the Z-spread or static spread) is the spread that must be added to Treasury spot rates that will cause the discounted value of the cash flows for an MBS or asset-backed security (ABS) to equal its price, assuming that the security is held until maturity. The chief drawback of the Z-spread is that it is not adjusted for prepayments risk.