CMBS FINAL COPY STUDY GUIDE 2023 All Possible
Questions and Answers with complete solution
Assuming a perfectly efficient debt market, what would be the forward rate during
year 6, given the following current spot rates?
Year: 1 2 3 4 5 6
Spot rate: .08 .085 .09 .095 .10 .105
((1+r6)^6/(1+r5)^5) - 1
2. Explain why, in the absence of transactions costs that spot interest rates
should be a geometric average of the imbedded forward interest rates. Explain
why, in an efficient market, we would expect a "naive" IRR or yield on a coupon
bond to be a complex average of yield curve spot rates.
- Spot rates and forward rates are inherently contingent upon each other.
- You can use forward rates or spot rates to find the other or vice versa
- Therefore if there are no transaction costs forward rates will be the average of current
spot rates
3. Van Order, in "Cracks in the Crystal Ball," expresses a widely held view among
economists about forecasting interest rates: "...forecasting interest rates is both
next to impossible and very dangerous." He concludes by stating that he is
"foreswearing financial forecasting, except for forecasts that are provided by the
market..." Explain what forecast methods he considers valid, and what he
believes they are useful for, given that they "cannot make money."
Best Methods:
1) Today's price is a good indicator of tomorrows price
2) The yield curve provides a forecast
a) can more accurately predict short and medium term rates compared to long term
rates
4. In the following model, find the value of the bond, with call and without. Find
the value to an investor (lender) if there is a 2 percent refinancing cost, paid to
third parties.
Initial interest rate: 11 percent
Change in interest rate per period: +/- 200 Basis Points
Bond coupon: $10
Par value: $100
Years remaining to maturity: 3 Years
Check Excel
5. For the problem above, compute the yield spread between non-callable and
callable (without refinancing fee). Suppose the callable bond is trading at a yield
100 basis points above comparable non-callable "Treasuries", what would be the
OAS?
Excel. Subtract the spread
, 6. Contrast the effect of increased interest rate volatility upon the value of callable
debt vs non-callable debt.
- As interest volatility increases, the value of non-callable debt increases and the value
of callable debt decreases.
- Callable debt can be "called on" when interest rates drop while noncallable cannot
7. Distinguish four sources of home mortgage prepayment. Discuss their relative
size, importance and predictability.
1. INTEREST RATE SHIFTS IS THE LARGEST FACTOR AFFECTING PREPAYMENT
2. Turnover - Individuals selling their house and relocating. *Important
a) Larger loans have less turnover
b) Type of loan: Some loans have higher turnover ex: ARMs
c) Property Type: Condos have higher turn over than single family homes
d) Housing Price Appreciation: If house prices rise individuals are more likely to sell
their home and relocate
3. Refinancing - receiving a new loan at a new interest rate *Important
a) If interest rates drop people are more likely to refinance
4. Default - Failure to pay
a) This decreases after month 30 hits
5. Curtailment - Unscheduled payments of the principal balance (Partial prepayment of
the loan)
a) Low in the beginning, increases up to 15-20% in the last 1/3 of the loans life
8. The largest single factor affecting prepayments on home mortgages is changes
in interest rates. However, the sensitivity of borrowers to changes in interest
rates is affected by a number of borrower characteristics, loan characteristics
and historical characteristics. Explain. Identify six or more important
characteristics of a home mortgage loan, of the borrower, or of the financial
environment that should affect the sensitivity of the borrower to interest rate
changes and the possibility of refinancing.
1. Remaining Loan Life - the longer remaining loan life the more likely a borrower will
refinance
2. Loan Size - Larger loans have larger payments. If interest rates drop they are more
likely to refinance
3. Economic Conditions - If the economy is good, people may have more money to
prepay loans early or refinance
4. Household Financial Conditions - If borrowers have more $
5. Burnout - If interest rates already dropped people may have refinanced already and
therefore if interest rates drop further their may not be a benefit to refinancing again
Questions and Answers with complete solution
Assuming a perfectly efficient debt market, what would be the forward rate during
year 6, given the following current spot rates?
Year: 1 2 3 4 5 6
Spot rate: .08 .085 .09 .095 .10 .105
((1+r6)^6/(1+r5)^5) - 1
2. Explain why, in the absence of transactions costs that spot interest rates
should be a geometric average of the imbedded forward interest rates. Explain
why, in an efficient market, we would expect a "naive" IRR or yield on a coupon
bond to be a complex average of yield curve spot rates.
- Spot rates and forward rates are inherently contingent upon each other.
- You can use forward rates or spot rates to find the other or vice versa
- Therefore if there are no transaction costs forward rates will be the average of current
spot rates
3. Van Order, in "Cracks in the Crystal Ball," expresses a widely held view among
economists about forecasting interest rates: "...forecasting interest rates is both
next to impossible and very dangerous." He concludes by stating that he is
"foreswearing financial forecasting, except for forecasts that are provided by the
market..." Explain what forecast methods he considers valid, and what he
believes they are useful for, given that they "cannot make money."
Best Methods:
1) Today's price is a good indicator of tomorrows price
2) The yield curve provides a forecast
a) can more accurately predict short and medium term rates compared to long term
rates
4. In the following model, find the value of the bond, with call and without. Find
the value to an investor (lender) if there is a 2 percent refinancing cost, paid to
third parties.
Initial interest rate: 11 percent
Change in interest rate per period: +/- 200 Basis Points
Bond coupon: $10
Par value: $100
Years remaining to maturity: 3 Years
Check Excel
5. For the problem above, compute the yield spread between non-callable and
callable (without refinancing fee). Suppose the callable bond is trading at a yield
100 basis points above comparable non-callable "Treasuries", what would be the
OAS?
Excel. Subtract the spread
, 6. Contrast the effect of increased interest rate volatility upon the value of callable
debt vs non-callable debt.
- As interest volatility increases, the value of non-callable debt increases and the value
of callable debt decreases.
- Callable debt can be "called on" when interest rates drop while noncallable cannot
7. Distinguish four sources of home mortgage prepayment. Discuss their relative
size, importance and predictability.
1. INTEREST RATE SHIFTS IS THE LARGEST FACTOR AFFECTING PREPAYMENT
2. Turnover - Individuals selling their house and relocating. *Important
a) Larger loans have less turnover
b) Type of loan: Some loans have higher turnover ex: ARMs
c) Property Type: Condos have higher turn over than single family homes
d) Housing Price Appreciation: If house prices rise individuals are more likely to sell
their home and relocate
3. Refinancing - receiving a new loan at a new interest rate *Important
a) If interest rates drop people are more likely to refinance
4. Default - Failure to pay
a) This decreases after month 30 hits
5. Curtailment - Unscheduled payments of the principal balance (Partial prepayment of
the loan)
a) Low in the beginning, increases up to 15-20% in the last 1/3 of the loans life
8. The largest single factor affecting prepayments on home mortgages is changes
in interest rates. However, the sensitivity of borrowers to changes in interest
rates is affected by a number of borrower characteristics, loan characteristics
and historical characteristics. Explain. Identify six or more important
characteristics of a home mortgage loan, of the borrower, or of the financial
environment that should affect the sensitivity of the borrower to interest rate
changes and the possibility of refinancing.
1. Remaining Loan Life - the longer remaining loan life the more likely a borrower will
refinance
2. Loan Size - Larger loans have larger payments. If interest rates drop they are more
likely to refinance
3. Economic Conditions - If the economy is good, people may have more money to
prepay loans early or refinance
4. Household Financial Conditions - If borrowers have more $
5. Burnout - If interest rates already dropped people may have refinanced already and
therefore if interest rates drop further their may not be a benefit to refinancing again
