Why is an assumed prepayment speed necessary to project the cash flow of a pass-through?
What will be an ideal response?
To value a pass-through security, it is necessary to project its cash flow. The difficulty is that the cash flow is unknown because of prepayments. The only way to project a cash flow is to make some assumption about the prepayment rate over the life of the underlying mortgage pool. The prepayment rate assumed is called the prepayment speedor, simply, speed. If the assumed prepayment rate is inaccurate or misleading, the resulting cash flow is not meaningful for valuing pass-throughs.
You might also like to view...
Dividend models suggest that the value of a financial asset is determined by future cash flows. A problem arises, however, in that future cash flows may be difficult to predict as to ________ of these cash flows
A) both the timing and the amount B) the timing but not the amount C) the amount but not the timing D) neither the timing nor the amount
On January 1, you invest $10,000 in an open-end mutual fund selling for $25 per share that has a 2% load, 1.5% management fee and 1% 12b-1 expense s
If the fund NAV appreciates to $28 by the time you sell it on December 31, what was your return on investment? A) 9.76% B) 11.2% C) 8.7% D) 14%