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FRM Part I · FRM Exam Part I · Mortgages and Mortgage-Backed Securities

A CMO is backed by USD 200 million of mortgages with a weighted average coupon of 6.0%. Tranche X (USD 120 million) pays 4.5% and Tranche Y (USD 80 million) pays 5.5%. Ignoring servicing fees and assuming all balances are outstanding for one year with no principal payments, what is the annual interest excess over the interest owed to tranches, and what does it imply?

The excess is USD 2.2 million. Collateral interest is 6% of 200 million, or 12.0 million, while tranches are owed 5.4 plus 4.4, or 9.8 million. The difference goes to the residual holder or serves as excess spread supporting the structure.

  1. AUSD 2.2 million, available as excess spread or to a residual trancheCorrect
  2. BUSD 1.2 million, available as excess spread or to a residual tranche
  3. CUSD 9.8 million, owed to the senior tranche
  4. DUSD 0.0 million, because collateral and tranche coupons must match

Explanation

Collateral interest is 200 × 6% = USD 12.0 million. Tranche interest is 120 × 4.5% = 5.4 plus 80 × 5.5% = 4.4, total 9.8. Excess is 12.0 − 9.8 = USD 2.2 million, which goes to a residual or serves as excess spread. The 9.8 figure is the tranche interest, not the excess.

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