Instructions 1. Order: Questions must be submitted in order. Any homework assignment with questions or parts of questions that are submitted out of order will receive no credit. The term order refers to the question numbers on the assignment. For example, if there are 5 questions, then the submitted solutions must be numbered from 1 to 5 in numerical order and each question must be answered completely under the appropriate number. Questions with subparts must also be answered in order.
2. Complete Assignment: to complete the assignment you must attempt all of the assigned problems/questions. If any of your answers are left blank or do not show sufficient effort the assignment will be marked incomplete. Incomplete assignments will receive no credit.
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Question I a) What requirements must be satisfied for GNMA to insure a securitization?
All bonds in the pool must be insured against default by one of the major agencies FHA – Federal Housing Administration VA – Veterans Association FMHA - Federal Farmers Home Administration b) What does GNMA insurance protect against?
GNMA insures the payments on pass through bonds. That is, if the SPV fails GNMA will take over the pool and ensure that pass-through bond holders receive timely payments of principal and interest. c) Is a GNMA bond comparable to a risk free Treasury note? Explain your answer?
Yes. The GNMA bond is based on a pool of mortgages that is insured against default. Further, the payments from the SPV to bond holders are also insured in the case where the SPV fails. So the bonds are essentially default risk free. d) What is the main risk do GNMA bond holders bear?
The main risk that GNMA bond holders face is prepayment risk. Mortgagees can prepay their mortgage, which will cause bond holders to lose a fraction of the promised interest payments. Unfortunately, prepayments mainly occur when interest rates are low. Therefore, GNMA bond holders are forced to reinvest prepaid principal at a lower rate Question II Last month, Collin-File Bank issued 500 commercial loans to a BBB rated corporations with an average size of $350,000 each. The loans were financed using demand deposits. Assume that this was the only change in the balance sheet for the month. a) How much new capital must the bank raise to maintain its current risk based capital ratio of 8%. Mortgages carry a risk weight (adjustment) of 50% from t he Basel Accord.? Let’s start with the risk-based capital ratio to set it equal to 8% We can rearrange the ratio as shown belowandget some insight into the question.
Capital Capital = (8%)( Risk − Adjusted Assets ) = 8% Risk − Adjusted Assets In this form, it’s easy to see that in order to maintain a capital ratio of 8%, we need to increase capital by 8% of the increase in risk adjusted asset value. Risk-adjusted assets increased by:
Risk − Adjusted Assets = (500 )(350,000 )(0.50) = 87,500,000 Then the increase in capital is 8% of that number:
Capital = (0.08)(87,500,000 ) = $7,000,000
b) How can the bank raise in capital?
There are several ways that the bank can raise...