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CMO Valuation

gsjayaraman

Joined
7/19/08
Messages
11
Points
11
Hi All,
I've been asked to value a CMO by this company as part of their interview process which i need to value using Monte Carlo simulation. Here are the terms of it:
Mortgage Term : 360 months
Monthly Payment: $2000 (P + I)
Mortgage holder can prepay a portion of the principal at any time
Initial Monthly interest rate= 0.075/12.
They have also given me the model to implement the process , consisting of stochastic interest rates and a stochastic prepayment model based on the interest rates. I'm getting a value of $243,146 when i value it. I was just wondering to know if it's something that seems approximately what it should be. Your 2 cents will be appreciated.
Cheers.
Sankar.
 
Plugging that bond into my financial calculator with 7.5% interest rates, I get about $286,000 as the PV. So it seems to be in the ball park by that metric; your answer should be lower with the prepayment risk. The interest rate risk may also lower the value (depends on the model of rate moves and the duration of the bond, I guess).
 
Thanks a bunch, mate. Now i feel a lot more relieved. I felt like i was shooting in the dark.
Cheers.
Sankar.
 
That's pretty straightforward bond pricing... shouldn't you have known that for your job app?
 
gsjayaraman said:
Hi All,
I've been asked to value a CMO by this company as part of their interview process which i need to value using Monte Carlo simulation. Here are the terms of it:
Mortgage Term : 360 months
Monthly Payment: $2000 (P + I)
Mortgage holder can prepay a portion of the principal at any time
Initial Monthly interest rate= 0.075/12.
They have also given me the model to implement the process , consisting of stochastic interest rates and a stochastic prepayment model based on the interest rates. I'm getting a value of $243,146 when i value it. I was just wondering to know if it's something that seems approximately what it should be. Your 2 cents will be appreciated.
Cheers.
Sankar.
Click to expand...

I am interested to know what kind of stochastic interest rate model they gave you. Is it a LIBOR model? Or a spot rate model? What is the correlation between the stochastic factors in these two models? Do they already calibrate the parameters?
 
It's actually the one proposed in the paper by Spassimir H. Paskov called "New Methodologies for Valuing Derivatives"
 
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