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Consider a small pool consisting of ten commercial mortgages, each with $10 million par value (that is, outstanding loan balance, or OLB) and a 10 percent coupon (contract) interest rate. (The coupon refers to the contract interest rate.) All ten mortgages are interest only-only balloon loans with annual interest payments at the end of the year. All of the mortgages are nonrecourse, with lockouts preventing prepayment. Five of the loans mature in exactly one year and the other five in exactly two years. Thus, the underlying pool is characterized by a total par value of $100 million, with a weighted average maturity (WAM) of 1.5 years and a weighted average coupon of (WAC) of 10 percent. Finally, suppose that the total value of all of the properties collateralizing the pool loans is $142.857 million. Thus, the pool has a par value of LTV of 70 percent ($100 million/$142.857 million). Three classes of securities have been created (amounts, coupons and yields) as follows: A $75.0mm (Coupon 8%, 8% yield) B $25.0mm (Coupon 10%, 12% yield) X (IO Class) $100.00 (Coupons: 1.5% year 1, 1.0% year 2; 8% yield) Classes A & B above have claims to both interest and principal while Class X is interest-only. All principal payments will be first used to retire tranche A. NOTE: Class X has a notional par value of $100 million representing the entire pool. The coupon drops on Class X from Year One to Year Two because of the scheduled pay down of the mortgages. Class X has a priority claim on interest equal to that of Class A. The overall cash flow to Class X is priced to yield 8%. Assume all mortgages perform in Year 1 but in year 2 one of the remaining five loans defaults on its $1 million interest payment. The loan is sold in foreclosure recovering net proceeds of $5 million. Thus the pool is short $6 million of contractual cash flows in year 2 that includes $5 million of principal and $1 million of interest. Given the loss and resulting shortfall of $6 million, the application the proceeds from the recovery and performance of the remaining mortgages are applied as follows: i. Interest due on all securities ii. Principal payments in terms of seniority. A. Prepare the schedule of cash flows (principal, interest) as if each mortgage performed according to their contracts. B. Prepare the schedule of cash flows (principal, interest) that will be recognized by the tranches given the loss incurred in Year 2. C. Populate the Pool Information table (Columns D through G) based on the initial mortgage information. D. Compute the proceeds of the securities sold for Year 0 (Column D35 to D41). HINT: Tranche A is sold with an 8% coupon to yield 8%, therefore it is sold at par. The three tranches will aggregate proceeds in excess of $100 million. E. Given the realized proceeds from B above, compute the IRRs for pool (Column G35 to G41).

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