Question #9 - Reading 27 Valuation and Analysis of Bonds With Embedded Options

Reading: Reading 27 Valuation and Analysis of Bonds With Embedded Options - Anwers

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- Matrix also currently has investments in several ABS. Which of the following spread measures is most appropriate in the analysis of ABS backed by credit card receivables? A) Monte Carlo simulation model, because representative paths can be utilized. B) Z-spread, because credit card ABS have no prepayment option. C) OAS, because the cash flows are interest rate path dependent. Explanation Credit card receivable-backed ABS have no prepayment option, therefore prepayments are not path dependent and the Z-spread is the most appropriate model. (Module 27.4, LOS 27.g) Alnoor Hudda, CFA, is valuing two floaters issued by Mateo Bank. Both floaters have a par value of $100, three year life and pay based on annual MRR. Hudda has generated the following binomial tree for MRR. 1-year forward rates starting in year: 0 1 2 2% 5.7798% 6.0512% 3.8743% 4.0562% 2.7190%

Question

Value of the cap in a capped floater with a cap of 4% is closest to:

Answer Choices:

A. $4.41

B. $1.29

C. $1.23 Explanation value of the cap = $100 – $98.71 = $1.29 The cap will be in the money for nodes 2,UU; 2,UL; and 1,U. V2,UU = 104/1.060512 = 98.07 V2,UL = 104/1.040562 = 99.95 V2,UL = 102.7190/1.027190 = 100 (Module 27.7, LOS 27.m)

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