BU Betting interest rates Worksheet

• Prior years of falling interest rates, dating back to post 9-11 monetary policy-induced economic recovery, fueled the growth of low quality SubPrime Mortgages in the United States .
• As the post 9-11 economic recovery/expansion slowed and weakened, significant workforce layoffs [sounds familiar?] led to larger than normal levels of defaults in this segment of the residential mortgages …
• … circa 2008 October, this (Subprime Mortgage) Financial Crisis quickyl caused significant stock market correction.
• The investment manager in the Case was exploring alternative investments for his high-net-worth clients — mortgage-backed securities (MBS) and credit default swaps (CDS).
• Learning goals:
  1. Introductory concepts to a subclass of Fixed Income securities — Asset-Backed Securities ABS — in particular, a further sub-class in Mortgage-Backed Securities MBS. This supplements your assigned textbook readings.
  2. Introductory concepts to the mechanics and cash flows of MBS [pg 3] and CDS [pg 5] — they are influenced by the level of defaults in the underlying pool of mortgages.
  3. How CDS, as a derivative on the flip-side of hedging, can be used to speculate the value of an underlying financial instrument, in this case, the mortgage pool.
  4. Understand the potential risks and rewards of various investment strategies that look to capitalize on the defaults on Subprime mortgages.
  5. Although events in this Case was more than 12 years ago, it looks like the United States will be facing another one soon — COVID-19 induced. There will be contrasting lessons (old and new) learned. We will have further learning opportunities to discuss similarities and differences with regard to the level/movement of interest rates, the mortgage market, global economic stimulus/recovery, central bank policies, and the financial markets in general.

Case Guidance: what to submit. Please read this entire Case.

1. Then take a look at Exhibit 5: Cash Flows from a Hypothetical CDS on MBS Transaction.
2. Download and use the attached Excel template file.
3. All questions for this assignment is in the Case Questions worksheet.
4. Make responses to all questions in the provided template worksheets.