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Hedging Case You are contacted by a small regional bank to see if you would be interested in purchasing three mortgage loans. You called a friend at a larger bank and he told you that his bank will purchase three loans from you in two and a half months for an upcoming securitization transaction that is eminent. You decide that you will purchase the three loans today and sell them in two and a half months to your friend.

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Hedging Case Before you purchase the loans, the seller tells you he will provide data and the terms of the sale for each loan. He then faxes you a sheet that has the following information on it… 1. Loan balance = 3,250,000, coupon = 7.5%, 12 bps servicing (servicing released), amortization term = 360, remaining term = 120, priced off the 10 year U.S. Treasury, spread = 225 bps 2. Loan balance = 5,500,000, coupon = 7.25%, 10 bps servicing (servicing retained), amortization term = 180, remaining term = 180, priced off the WAL, spread = 235 bps 3. Loan balance = 2,000,000, coupon = 8.375%, 15 bps servicing (servicing released), amortization term = 360, remaining term = 84, priced off the 7 year U.S. Treasury, spread = 300 bps

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Hedging Case Question 1: The seller also asks you if you would indicate the price you would pay for each loan based upon current U.S. Treasury rates? Question 2: Your boss asks you to calculate the exact hedge you would recommend if you hedged these loans with U.S. Treasuries? Assumptions: Make sure that you update the U.S. Treasury Curve before answering Questions 1 and 2. Use the following assumptions: Settlement Date (11/19/2008) Input the current U.S. Treasury Coupons and Maturity Dates for each U.S. Treasury that is shown on Bloomberg http://www.bloomberg.com/markets/rates/index.html http://www.bloomberg.com/markets/rates/index.html Use the following U.S. Treasury Prices… 2 Yr Treasury Price (100-18+) 3 Yr Treasury Price (100-22) 5 Yr Treasury Price (102-02+) 10 Yr Treasury Price (100-17+) 30 Yr Treasury Price (105-12)

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Hedging Case On the last day of class, be prepared to turn in the following: your hedging model; the three loans modeled up with their calculated price, WAL, modified duration, and DV01; and your recommended hedge.

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