Choosing MBS Prepayment Rates for Monthly Cash Flow Projections

Summary

The document clarifies which prepayment convention to use when projecting mortgage pass-through security cash flows. For standard US pass-throughs that pay monthly, it points to the single monthly mortality rate (SMM), because it expresses prepayment on a monthly basis. The question gives an example security with a stated balance, pass-through rate, weighted average coupon and maturity, and asks for its next two months of cash flows under a PSA assumption, but the answer does not calculate those cash flows.

The answer distinguishes three quotation conventions: SMM is monthly, conditional prepayment rate (CPR) is annualized, and PSA represents a sequence of CPR rates, or equivalently SMM rates. The practical lesson is to match the rate convention to the payment period and convert or interpret assumptions consistently. The explanation is brief and does not lay out a full amortization or cash flow calculation; actual projections also require applying the selected prepayment assumptions to the mortgage pool and its scheduled payments.

Key ideas

• For a standard US MBS with monthly payments, use a monthly prepayment rate such as SMM.
• CPR is an annualized prepayment convention, while SMM is monthly.
• PSA specifies a sequence of CPR rates and can be represented equivalently as SMM rates.
• The document identifies the relevant convention but does not work through the example cash flows.

Tags

# How to determine the cash flows of a Mortgage backed security?


# How to determine the cash flows of a Mortgage backed security?












Suppose there is a $400 million mortgage pass-through security with a 7.5% pass-through rate, a weighted average coupon of 8.125% and a weighted average maturity of 357 months, how to compute the cash flows for the next two months assuming a 100 Principal Securities Association(PSA)?

I am quite confused as to whether I have to use the single monthly mortality rate or the conditional prepayment rate to arrive at the solution. Any leads or solutions would be highly helpful.

## Answer by Sharad (score 1)

https://quant.stackexchange.com/a/58113

Generally speaking, you would want to know the payment frequency of the MBS to know which prepayment assumption to use. In the U.S., the standard MBS pass-through security has monthly cash flows so in this case you would want to use the SMM, which is a monthly prepayment rate.

SMM, CPR and PSA are all examples of quotation conventions for prepayment rates; SMM is a monthly rate, CPR is an annualized rate, and PSA corresponds to a vector of CPRs (or, equivalently, SMMs).

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.