Municipals and Mortgagebacked Securities

1
Municipals andMortgage-backed Securities

• GBUS 8107 Fixed Income
• Rick Boebel

2
Class Outline

• Virginia public school case
• See questions on web site
• Mortgage Backed Securities
• Risk
• Prepayment

3
Class review

• JPM Article
• Factors
• Out of sample testing
• In equities what would this strategy be called?

• Municipal bonds
• Who should buy them?
• How does the market work?
• Any scandals?

4
Equivalent Taxable Yield

• Bid yield 5.45
• Atlanta GAwtrwsteSr, 5.000, 11-01-39

5
Municipal issuing/trading

• Unlike other bonds quoted in yield
• Primary market
• Secondary market
• Liquidity?
• Why do NYC bonds yield less than Houston?

6
Virginia public school case

• Assume you are Trent Stephens, complete a bid
  with a specific TIC (true interest cost), coupon
  scale, and bid amount. You have the following
  guidelines
• 8/1/2000(3yr),0.250 concession, price at
  premium
  
• 8/1/2018(3yr),0.375 concession, price at
  discount
  
• Give a par amount, sale date, dated date,
  delivery date, first interest day, yield bids and
  concession. Yield bids should be for each
  maturity.
• The total should generate an 80K residual spread
  and meet the above guidelines.
  
• If you offered the longer maturities at a
  discount could you make money on these bonds? If
  you were willing to settle for 50K , how would
  that change the lowest TIC you could generate.
• What is the logic behind all of the issuers
  constraints?

7
Mortgage-Backed Securities

• Represents a strong movement in investments
• Securitization
• Mortgages used to be held for life by issuer
• Mortgages now packaged and sold so that lenders
  can gain liquidity
  
• One of biggest markets, 3 trillion!
• What are problems for mortgage backs that had to
  be solved?

8
Risk

• Large pools for diversification
• Government National Mortgage Assoc.
• Ginnie Mae
• guarantees FHA VA mortgages
• Federal National Mortgage Assoc. and Federal Home
  Loan Mortgage Corp
  
• Fannie Mae and Freddie Mac
• guarantees conforming conventional mortgages
• Other private guarantees for non-conforming

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Prepayment

• Embedded Prepayment Option
• What does this mean?
• How does this effect duration and convexity?
• Causes
• Prevailing mortgage rate
• spread between contract and current rate
• path of mortgage rates
• level of mortgage rates
• type of mortgage loan
• seasonal factors
• general economic activity
• Prepayment models (PSA)

10
Prepayment Behavior 1

• Necessary to project cash-flows!
• CFs depend on prepayments called conditional
  prepayment rate (CPR)
  
• Public Securities Assoc. (PSA) prepayment
  assumptions
  
• CPR increasing 0.2 per month for 30 months to
  6
  
• then 6 for life of security
• Can be faster or slower, 150 PSA9 CPR

11
Thursday Class

• Collateralized Mortgage Obligations
• Sequentially pay
• Accrual
• Floaters
• Planned Amortization
• Option adjusted spreads

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Class Summary

• Virginia public school case
• See questions on web site
• Mortgage Backed Securities
• Risk
• Prepayment