one question of calculating expected return of a bond due in 8hrs

FIU REE 6200

Guidelines for Case Study

The Return of the Loan

1. The Goal

In 2010 Zoe Greenwood, a vice president at an investment advisory firm, was asked to recommend to her life insurance company client an investment into commercial real estate debt. Although an increase in direct commercial mortgage lending was a possibility, Greenwood also considered bonds from a soon-to-be-issued commercial mortgage-backed security (CMBS). These bonds were the first CMBS bonds backed by loans to multiple borrowers since credit markets had frozen during the financial crisis. Greenwood had to analyze whether the new CMBS could offer her client a superior risk-return tradeoff compared with making individual mortgage loans. Ultimately, students are to make the recommendation that they believe Greenwood should make to United Principal Life (UPL).

2. Learning Objectives

· Learn how to construct promised cash flows from both commercial mortgages and commercial mortgage-backed securities

· Understand the benefits and costs of direct lending versus indirect lending (purchase of mortgage-backed bonds)

· Underwrite commercial mortgages issued by others to identify potentially hidden risks

· Evaluate at what price a mortgage-bond investment makes financial sense

3. Major Steps for Students to Build Up Your Recommendation

1) Construct the promised cash flows to directly lending $5.8 million in commercial mortgages using the information contained in Exhibit 6. Estimate the expected return on direct lending.

2) Construct the promised cash flows from an investment in each of the five principal receiving bonds. Disregard the X bond.

3) Qualitatively discuss the benefits and costs of making direct mortgage investments rather than an investment in the D-bond of their particular CMBS deal. As part of this discussion, you should consider the relative expected rates of return for the two investment strategies.

4) Review the underwriting of each of the six loans in the CMBS deal. Based on your review of the loan documentation, which loan(s) in the CMBS deal cause you the most concern about future potential losses? Why?

5) Based on your analysis in step 4), identify an adverse economic scenario that you believe is most likely to cause at least one of the CBS loans to default. The scenario should outline the economic reason/event that would lead to a borrower being unable to satisfy its debt service requirements. Assign a probability to this scenario, calculate the expected return to the affected loans, and calculate the expected cash flows to the D-bond.

6) Determine the expected return you would require if purchasing the D-bond. Using that return expectation, calculate the face value you would expect to acquire with your $5.8 million purchase. That is, at what price (relative to par) would you need to acquire the D-bond to prefer the D-bond over direct mortgage investment?

4. Other issues

· A group of 3-4 members should be formed to complete the case study

· Suggestions for the case report: double-space, 10 or more pages, including tables

· Please submit your case report in Microsoft Word format via Canvas Assignments

· The case is due on December 3rd @5:30 PM ET