More volatility in cash flow and therefore price volatiilty

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Reference no: EM131183413

An issuer is trying to structure a floating rate tranche in a CMO offering. The tranche will be backed by mortgages with 8% interest rate and current balance of $2000000. Interest payable to investors in the floating rate securities (F) and investors floater securities (IF) will be based on an initial, or base, market rate of 8%. Investors in the F portion of the tranche will be benefit to the extent of any increases from the base rate of interest and (IF) investors extent of any will benefit to the extent of any decreases from the bas rate. a) Assuming that F and IF portions of the tranche are equal (50% each) what will the share of interest be for each class of investors of the day of issue? A maximum cap must be set on increases in the base rate of interest for the F investors. What would such a cap be? What would be the floor for the IF portion of offering? b) Assume IF buyers prefer a levearaged offering. If the terms in (a) were altered to a ratio of 60% to F investors, what would the interest allocation be on the day of the issue? What would the cap and floor be? c) Compare the terms in (a) and (b). Assume now that a 2% increase from the base rate of 8% occurs immediately after CMO offering. What happens to the cash distributions to the F and IF investors? Assume that a 2% decrease from the base rate occurs. What happens to the cash distributions? Which class of investors experiences more volatility in cash flow and therefore price volatiilty? why?

Reference no: EM131183413

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