Wednesday 4 June 2014

Valuation of Mortgage-backed Securities

If we want to calculate the Return of any mortgage-backed Security than first of all we need to first calculate the WAC (Weighted Avg Coupon) of that security, and as we know that investors return is always be less than the WAC, For example if Mortgage-backed Security ‘A’ is backed by four loans, So we just calculate the Weighted Avg Coupon of this four loans, say suppose the WAC of that Security is 6% then we can say that the return on that mortgage-backed Security should be in between of 5.6%-5.9%. This is the simplest way to calculate the Value and Return of that security.  Below you can find the calculation of WAC and Return Of Mortgage-backed Security.

Valuation Model Of Mortgage-backed Securities
Valuation Model Of Mortgage-backed Securities
From above calculation we can get the idea that how to calculate the Return on Mortgage-backed Securities. And the main thing from above calculation we can see is WAC is directly proportional to the Expected return on mortgage-backed Security, So let’s suppose if the WAC is 8% than the Expected return will be nearly 7.5%-7.9%

From Above Figure we come to know that there is a direct Relationship between WAC and Expected Return on MBS.

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