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MRMM-16-techniques-for-valuing-mbs.html
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<!doctype html>
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<title>Market Risk Measurement and Management | Chapter 16 | Techniques for Valuing MBS</title>
<meta name="description" content="Financial Risk Manager Part 2 Study Materials">
<meta name="author" content="MacLane Wilkison">
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<section>
<h1>Chapter 16</h1>
<h3>Techniques for Valuing MBS</h3>
<p>
<small>Created for <a href="http://alchemistsacademy.com">Alchemists Academy</a> by <a href="http://alchemistsacademy.com/about">MacLane Wilkison</a></small>
</p>
</section>
<section>
<h2>Static Cash Flow Yield Analysis</h2>
<ul>
<li>Must assume a certain prepayment rate</li>
<li>Bond equivalent yield (BEY) = 2[(1+i<sub>m</sub>/12)<sup>6</sup>-1]</li>
<li>Nominal spread - the difference between the cash flow yield and the Treasury yield</li>
</ul>
</section>
<section>
<h2>Z-Spread</h2>
<p>A measure of the spread that an investor would realize over the Treasury spot rate curve if the mortgage security were held to maturity</p>
</section>
<section>
<h2>Monte Carlo Simulation</h2>
<p><em>Definition: A simulation generating a set of cash flows based on simulated future mortgage rates</em></p>
<ul>
<li>Steps:</li>
<ol>
<li>Simulate short-term interest rate and refinancing rate paths</li>
<li>Project the cash flow on each interest rate path</li>
<li>Determine the PV of the cash flows on each interest rate path</li>
<li>Compute the theoretical value of the mortgage security</li>
</ol>
</ul>
</section>
<section>
<h2>Option-Adjusted Spread (OAS)</h2>
<p><em>Definition: The spread (K) that, when added to all the spot rates of all interest rate paths, makes the average PV of the paths equal to the observed market price</em></p>
<ul>
<li>Accounts for the option of borrowers to prepay</li>
<li>Option cost = Zero-volatility OAS - OAS</li>
</ul>
<aside class="notes">
The zero-volatility OAS is calculated in the same was as the OAS but only the base-case interest rate path is considered.
</aside>
</section>
<section>
<h2>Total Return Analysis</h2>
<ul>
<li>Enables investors to evaluate returns over different horizons and interest rate scenarios</li>
<li>Total return = Total horizon proceeds/Total cost) - 1</li>
<uL>
<li>If there are interim cash flows, these should be accounted for as well</li>
</ul>
</ul>
</section>
<section>
<h1>THE END</h1>
<h3><a href="http://alchemistsacademy.com">AlchemistsAcademy.com</a></h3>
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