Ontario Home Funding
by Professor Ian H. Giddy
New York University
Mortgage and Housing
Corporation is about to purchase a C$1 billion pool of mortgage loans
from several banks in Ontario. Your
team has been placed in charge of
the funding and risk management of this pool. The
goal is to issue a mortgage-backed security that will appeal to
such a way as to closely match the risk characteristics
of pool. The details of the pool, simplified for computational
purposes, are shown below.
|Pool interest rate
|Pool maturity date
|Historical default rate
annual principal prepayment
The following chart illustrates the
paydown structure of the loan pool.
Your task is to arrange funding and manage the interest rate and credit
risks of the mortgage loan pool using securitization techniques.
- First, recommend a conventional bond that
could be issued to fund the pool.
The bond must be a fixed coupon, bullet maturity noncallable bond. CMCH
can issue such bonds at a coupon rate of 3.75%. You
may use this spreadsheet: loan_amortization.xls. What is the duration mismatch
between the asset and
the liability? Who bears the credit risk?
- Next, assume that the pool can be
securitized by setting up a SPV and issuing 5 tranches of
mortgage-backed securities. Please design such a mortgage-backed
security, in such a way as to minimize any interest rate risk or credit
risk to CMCH, which will hold the "residual" tranche.