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发表于 2012-4-2 18:51
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Paul Wilken works in the structured-product group of a large investment bank. One of his new tasks is to perform valuation analysis on mortgage-backed and asset-backed securities. Wilken has not worked with mortgage-backed securities (MBS) or asset-backed securities (ABS) in several years, so he takes some time to reacquaint himself with the many measures used to value these types of securities.
Wilken begins with the cash flow yield. He believes the cash flow yield is of little use in real-life situations. He records the following assumptions of the cash flow yield. - All cash flows will come in on schedule.
- All interim cash flows are reinvested at the cash flow yield.
- Default risk associated with the underlying loans is constant over the life of the security.
- Mortgage-backed or asset-backed securities are held until the final payout.
Wilken then turns his attention to the nominal spread, which he finds more useful than the cash flow yield.
After reviewing the basics, Wilken begins work on his valuations. He has some experience using interest-rate lattice models to price interest-rate derivatives. However, he has read that the lattice-based backward-induction method cannot be used to value mortgage-backed securities (MBS). Instead, he considers the merits of zero-volatility spreads and Monte Carlo simulations.
Wilken begins his bond-valuation assignment by considering two securities – a bond backed by credit-card loans, and a bond backed by home-equity loans.
Wilken assigns a junior researcher, Michelle Zoellick, to help with his bond valuations. Her first job is to determine the effective durations of a series of bonds. Zoellick soon realizes that all of the dealers used by the investment bank provide different estimates for effective duration. She tries to determine why this is so, and concludes that the numbers are not equal because vendors use different assumptions for:- Prepayment assumptions
- Option-adjusted spreads (OASs)
- Credit risk
- Interest-rate volatility
Which of the following spreads are best used to value the asset-backed securities below?
| Credit-card ABS | Home-equity loan ABS |
Credit-card loans do not have prepayment options, and as such can be valued using the zero-volatility spread, which does not take options into account. Bonds backed by home-equity loans do have prepayment risk, and as such require an option-adjusted spread. (Study Session 15, LOS 53.i)
Which of the following assumptions is least likely a limitation of the cash flow yield measure? A)
| MBS or ABSs are held until the final payout. |
| B)
| All cash flows will come in on schedule. |
| C)
| Default risk associated with the underlying loans is constant over the life of the security. |
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The cash flow yield measure does not rely on any credit risk assumption. The other assumptions apply to the cash flow yield, and all represent a weakness of the metric, because they are not practical in a real-life context. (Study Session 15, LOS 53.a)
Which of the following is least likely a reason why effective duration estimates differ from vendor to vendor? A)
| Prepayment assumptions. |
| | |
Credit risk is generally built into a bond’s yield and price, and no estimates of it are needed to compute effective duration. The other assumptions can differ from vendor to vendor and result in different quote for effective duration. (Study Session 15, LOS 53.f)
Which of the following statements about the nominal spread is most accurate relative to MBSs? A)
| A portion of the spread reflects prepayment risk. |
| B)
| The nominal spread and the Z-spread begin to converge when the yield curve steepens. |
| C)
| Nominal spreads can only be calculated using a Monte Carlo simulation. |
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The nominal spread includes some compensation for prepayment risk, but investors cannot tell how much of the spread reflects that risk. Analysts can calculate nominal spreads without a Monte Carlo simulation. The difference between the nominal and zero-volatility spreads widens when the slope of the yield curve increases. (Study Session 15, LOS 53.a)
Which of the following is a reason why the lattice-based backward-induction method is ineffective for valuing a MBS. The method cannot handle: A)
| the path dependency of cash flows. |
| B)
| variable interest rates. |
| |
MBS prepayments depend on the level of the interest rate at a particular point in time and also on the path the interest rate has taken in order to get to a certain level. Backward induction can't easily capture path-dependent cash flows, and as such is not useful for predicting prepayments. Backward induction can account for call options and variable interest rates. (Study Session 15, LOS 53.c)
Which of the following statements about Monte Carlo simulations is least accurate? A)
| The simulations can compensate for prepayment burnout. |
| B)
| The simulations determine value by adding the zero-volatility spread to every spot rate along every interest-rate path. |
| C)
| Effective models must include assumptions about interest-rate paths, rate volatility, benchmark interest rates, and prepayments. |
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Monte Carlo simulations add the OAS to every spot rate. The other statements are true. (Study Session 15, LOS 53.d) |
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