Financial Risk Manager Part 1
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A fixed-income portfolio manager has recently acquired a seasoned 5% agency Mortgage-Backed Security (MBS) with a weighted average loan age (WALA) of 60 months. At the beginning of the month, the current loan balance for this MBS stands at USD 32 million. Given that the constant conditional prepayment rate (CPR) is 0.6% annually, calculate the closest estimate for the expected principal prepayment amount for this month.
Exam-Like
A
USD 3,210
B
USD9,600
C
USD16,000
D
USD16,045
Explanation:
D is correct. The conditional prepayment rate (CPR) is related to the single monthly mortality rate (SMM) as follows: CPR = 1 - (1 - SMM)^12. And so, SMM = 1 - (1 - CPR)^(1/12) = 1 - (1 - 0.006)^(1/12) = 0.0005014 = 0.05014%. The expected principal prepayment is equal to the percentage of principal outstanding at the beginning of the month that is prepaid during the month = 32,000,000 * 0.0005014 = USD 16,044.80.*
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