(BQ) Part 2 book “Fixed income analysis” has contents: Valuing mortgage-backed and asset-backed securities, interest rate derivative instruments, valuation of interest rate derivative instruments, general principles of credit analysis, introduction to bond portfolio management, and other contents. | CHAPTER 12 VALUING MORTGAGE-BACKED AND ASSET-BACKED SECURITIES I. INTRODUCTION In the two previous chapters, we looked at mortgage-backed and asset-backed securities. Our focus was on understanding the risks associated with investing in these securities, how they are created (., how they are structured), and why the products are created. Specifically, in the case of agency mortgage-backed securities we saw how prepayment risk can be redistributed among different tranches to create securities with a prepayment risk profile that is different from the underlying pool of mortgages. For asset-backed securities and nonagency mortgage-backed security, we saw how to create tranches with different degrees of credit risk. What we did not discuss in describing these securities is how to value them and how to quantify their exposure to interest rate risk. That is, we know, for example, that a support tranche in a CMO structure has greater prepayment risk than a planned amortization class (PAC) tranche. However, how do we determine whether or not the price at which a support tranche is offered in the market adequately compensates for the greater prepayment risk? In this chapter, we will describe and then apply a methodology for valuing mortgagebacked securities and some types of asset-backed securities—Monte Carlo simulation. As we stressed in Chapter 9, a byproduct of a valuation model is the option-adjusted spread. We will see how the option-adjusted spread for a mortgage-backed or an asset-backed security is computed and applied. From a valuation model the effective duration and effective convexity of any security can be computed. We will explain how to compute effective duration and effective convexity using the Monte Carlo simulation model. However, in the case of mortgage-backed securities, there have been several alternative measures of duration used by practitioners. These measures will be identified along with their advantages and disadvantages. Admittedly, the .
