There are some securities that are backed by a pool of loans. These loans have a...
There are some securities that are backed by a pool of loans. These loans have a schedule of interest and principal payments every month and give each borrower whose loan is in the pool the right to payoff their respective loan at any time at par.
Suppose that a portfolio manager purchased one of these securities. Can the portfolio manager rely on the schedule of interest and principal payments in determining the cash flow that will be generated by such securities (assuming no borrowers default)? Why or why not?
Homework Answers
Since it is mentioned that no borrowers default, portfolio manager can rely on the schedule of interest and principal payments. The loans have a fixed schedule of interest and principal payments every month and as such by combining the interest and prinicipal payments of each loan, the cash flow of the securities can be determined. The only uncertainly is the prepatment option which is there, but that would only increase the cash flow and thus would not hinder to interest/principal payouts to portfolio manager.
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