Question

Consider a sequential pay cmo that is backed by 60 mortgages with average balance of $100,000 each. the mortgages have monthly payments with wam = 15 years and wac = 4%. there is a servicing fee of 0.6% and prepayment is according to 100% psa. there are three tranches in this cmo: tranch a issued for $2,000,000, tranche b issued for $2,000,000, and a z-bond issued for $2,000,000. how much cash flow do investors in tranche a receive in the first month?

Answer 1

Investors in Tranche A of a sequential pay CMO will receive the total monthly mortgage payments after servicing fees. To calculate the cash flow, one needs the monthly payment for one mortgage, total number of mortgages, and servicing fees. Tranche A gets paid first before other tranches, and expected cash flow would need to account for the interest rate, prepayment speed, and servicing fees.

Step-by-step explanation:

The student is asking about the cash flow that the investors in Tranche A of a sequential pay Collateralized Mortgage Obligation (CMO) will receive in the first month. The CMO is backed by 60 mortgages with an average balance of $100,000 each, a Weighted Average Maturity (WAM) of 15 years, a Weighted Average Coupon (WAC) of 4%, and prepayments are according to 100% Public Securities Association (PSA). Additionally, there is a servicing fee of 0.6%.

First, we need to calculate the total monthly payment of the mortgages. Since this CMO has 60 mortgages of $100,000 each, the total balance is $6,000,000. Using the formula for the monthly payment M for a mortgage, which is M = P[r(1+r)^n]/[(1+r)^n - 1], where P = principal, r = monthly interest rate, and n = total number of payments, we find the monthly payment for one mortgage and then multiply by 60 to find the total monthly payment for all mortgages.

For the servicing fee, you would take 0.6% of the total monthly payment and subtract it from the payment to find out what goes to investors. Finally, for Tranche A investors, since this is a sequential pay CMO, they will receive their payments first before Tranche B and the Z-bond. Assuming there are no losses and prepayment speeds are as projected, the cash flow will simply be the applicable share of the monthly payment after servicing fees, until their tranche is fully paid.

For an exact calculation, you would need a detailed amortization schedule that factors in the WAC, servicing fees, and prepayment speeds, which is beyond the scope of this response. A simplified example has been provided, and in practice, a detailed financial model would be used to determine cash flows.