As a financial adviser to individual investors, your boss has asked you to write a memo to him so that he can recommend a mortgage-backed bond to a client. The client has a particular corporate bond in mind, but your boss thinks that a pass-through mortgage-backed security would provide a better yield at the same risk level and maturity. The bond that the client is considering is a 7-year, AA-rated bond with a 6.75% coupon. When it matures, the proceeds will be used for and are matched exactly with the cost of his daughterâ€™s college education, which will be paid in one lump sum. The bond your boss favors is a pass-through MBS (also 7-year with an AA rating), featuring a 7.15% coupon. Your economic research department just released a research report that predicts that interest rates are going to decline over the next several years to historical lows.
Write a memo to your boss of at least 300 words that provides the following:
- Your recommendation
- At least 3 reasons you considered to develop your recommendation
Shortly after you were given this task, you became aware of a new CMO issue that has an AA-rated, 7-year Class A VADM tranche, with a 7.00% coupon that uses a Z bond to protect against prepayment and
extension risk. Write a second memo to your boss of at least 300 words that offers the following:
- What the acronym VADM means in the context of MBS
- A description of the new CMO tranche and how it may or may not be a better choice for the client than the corporate bond and the MBS that your boss initially recommended