CFA Practice Question

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CFA Practice Question

An investor currently owns an MBS that has a coupon rate of 7% and a pro rata share of principal in the amount of $22,000. The scheduled principal repayment to the investor for the current month is $284 and the conditional prepayment rate (CPR) is assumed to be 9% for the year. Which of the following would best estimate the total cash flow that can be expected from this particular MBS for the upcoming month?
A. $476.28
B. $582.33
C. $734.85
Explanation: SMM = 1 - (1 - CPR)1/12 = 0.783%

Prepayment for the month = SMM [(Beginning mortgage balance) - (Scheduled principal repayment)] = 0.0078284 (22000 - 284) = $170.00

Total cash flow = coupon payment (0.07/12 x 22,000) + scheduled principal repayment (284) + prepayment expected for the month (170) = $582.33

User Contributed Comments 2

User Comment
bmeisner Wouldn't the monthly coupon = (1.035)^(1/6)? I think we need to make the bond equivalent yield adjustment. Anyone know?
HenryQ Good point. 0.07/12 is for simplicity though. The textbook uses this approach as well. The main point is SMM.
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