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Pricing and Valuation Analysis of Fixed Rate Mortgages
Pyramid Mortgage Finance Company (PMFC)
I. Executive Summary
Pyramid Mortgage Finance Company (PMFC) originated four balloon mortgages of $500,000, each amortized over 25 years and an original term of 11 years. We have analyzed several elements of these mortgages. Through the analysis, we have identified several issues with the current mortgage portfolio and have offered recommendations. The analysis included appropriate pricing of the mortgages, structure of the mortgage offerings in relation to handling of discount points, potential liquidation of the mortgages and hedging opportunities.
Key findings that contributed to our recommendations include:
• PFMC could hedge against rising interest rate risk and have the potential to realize gains if interest rates decrease.
• Although selling the mortgages would incur an initial loss of capital, the funds from the sale could be invested at the current market rate of 8.5% to garner high yields.
Based on these conclusions, we recommend that PFMC sell the mortgages unless they can guarantee they can receive an 8.5% or higher constant return on the payments they receive from the mortgages.
II. Purpose of Analysis
Purpose: The critical questions that need to be addressed in the PMFC portfolio include, but are not limited to:
• Were the mortgages properly priced a year ago?
• Since PMFC is in need of cash, should the mortgages be liquidated?
• If the mortgages should be liquidated, what is the maximum liquidation value or price of the mortgages?
• ...