Calculating Prepayment Speeds
Prepayment assumptions, that is, estimates based on historic prepayment rates for each particular type of mortgage loan under various economic conditions from various geographic areas, are factored into the offering price, “yield,” and market value of a CMO. The realization of the average life and yield estimates depends on the accuracy of the prepayment assumptions. Different standard and proprietary prepayment rate models exist, but one of the most common ways of expressing prepayment rates is in terms of the Standard Prepayment Model of the Securities Industry and Financial Markets Association. Developed in 1985 for specific application to mortgage securities, the Association’s Model assumes that new mortgage loans are less likely to be prepaid than somewhat older, more “seasoned” mortgage loans. Projected and historical prepayment rates are often expressed as “percentage of PSA” (Prepayment Speed Assumptions). (See Glossary for a more complete definition of the Association’s Model.)
All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association from our membership and other sources believed by the Association to be accurate and reliable. By providing this general information, the Securities Industry and Financial Markets Association makes neither a recommendation as to the appropriateness of investing in fixed-income securities nor is it providing any specific investment advice for any particular investor. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and sources may be required to make informed investment decisions.