Fixed Income Securities

Fixed Income Securities

Assignment

Q1. Why the travelers issues CMO rather than GNMA’s and reinvesting in 5Years instruments.

Answer:

The travelers issues CMO rather than GNMA and reinvesting in 5Years instruments, because in 1984 the demand for the CMO has increased in the fixed income investors, making it much more attractive as CMO’s were priced at prepayment assumptions on the basis of the cash flow yields where as GNMA’s were relatively insensitive to prepayment assumptions and were priced at reflected quoted yields to a 12-year life.

GNMA’s were to prepay at constant annual rates outstanding principal per year where as CMO’s is modeled as changes in prepayment rates over the life of a mortgage pool. The prepayment rates were usually slowest early in the life of a mortgage pool which was critical to providing buyers of the shortest maturity class in a CMO series with an adequate return.

Providing the flexibility in the annual rates and repayment of the principal amount according to the superior and subordinate class, provides CMO were chosen over the in the fixed income securities market.

Thus, travelers issued CMO rather than GNMA and reinvesting in 5Years instruments.

Q2. What were the challenges Miss Golden would be facing in pricing Traveler’s CMO’s.

Answer:

The challenges that Miss Golden would be facing while pricing Traveler’s CMO’s were:

* Collateralized mortgage obligations (CMO’s) has recently been introduced in the fixed income securities industry having no historical data for valuation, making it difficult for such a security to be priced.

* CMO consisted of four classes of securities making it a challenge for pricing the CMO.

* CMO’s were complex fixed income securities in which the...