The XYZ Mortgage Company is issuing a CMO with three tranche

The XYZ Mortgage Company is issuing a CMO with three tranches. The A tranche will consist of $60.5 million with a coupon of 8.75 percent. The B tranche will be issued with a coupon of 9.5 percent and a principal of $32.5 million. The Z tranche will carry a coupon of 10.5 percent with a principal of $55 million. The mortgages backing the security issue were originated at a fixed rate of 10.5 percent with a maturity of 10 years (annual payments). What is the CMO’s weighted average coupon (WAC) at issuance?

Solution

WAC is calculated by multiplying the coupon rate of each mortgage or its backing security by its remaining balance, adding all products and then dividing the result by the remaining balance.

Now as the total balance = 60.5+ 32.5+55 = $148 million

So remaining balance after mortgage of A tranche = 148 - 60.5 = $87.5 million

and % rate on first balance = 60.5/148 = 40.88%=0.4088

Similarly % rate on second balance = 32.5/148 = 22%=0.22

And % rate on third balance = 55/148=37.16% =0.3716

Thus total WAC at the time of issue

= 0.4088 x 0.0875 + 0.22 x 0.095 + 0.3716 x 0.105 =0.09567

=9.56%

So required WAC is 9.56%

Answer