Question:
My traders continue to overpay for PO bonds. Could you please let me know the
variables to use when pricing and trading a PO bond?
Answer:
There are different types of PO bonds, such as PAC, TAC, SC, SEQ, PT, STP SUP, PO
or Remics, etc.
You must take the following factors into consideration before submitting a bid or
asking for a PO bond:
• The uncertainty of loan payments due to poor documentation and human error;
• Costs of hedging;
• Option;
• Scaling up prepayment models vectoring out the PSA/CPR with emphasis on key
attributes, modified duration, effective duration, average life and convexity
using YB, Bloomberg or INTEX;
• Forecasting payments given inflation, mortgage services fees and loan balances;
• Is the collateral backed by GNMA, FNMA, FHLMC or a private label (whole loan
CMO)?
PO(A) PO(B) PO(C)