DB Liquid Mortgage-Backed Security Index

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1 12 January 2012 DBIQ Index Guide DB Liquid Mortgage-Backed Security Index Summary The DB Liquid Mortgage-Backed Security Index aims to provide investors with a simple way to track the performance of the US Agency Mortgage market. The Selection methodology for the index ensures that the index is made up of the most liquid segments of the mortgage market to allow better and more reliable pricing The Weighting methodology of the index is based on the entire principal balance outstanding for a particular Coupon/Agency/Maturity combination across all production years to enable wider market coverage Tracking error versus other similar benchmark indices is small. The historical levels of the index have been calculated from 1 January Historical DB Liquid MBS Total Return Index Level Source: Deutsche Bank. All levels provided herein are indicative and do not guarantee future performance. Index Development Contacts: London: +44 (0) New York: +1 (0)

2 12 January 2012 Introduction to DBIQ DBIQ is Deutsche Bank s web-based platform that provides sophisticated support for index and portfolio analysis. The site allows users to report on index, portfolio, pricing and bond level information in an intuitive, transparent and customizable way. The DBIQ system was designed with ease of use, speed, flexibility and a large array of data in mind. The DBIQ index family covers the global fixed income, FX, commodities and derivatives world. All indices are designed to be transparent and market reflective. Index Description The US agency mortgage-backed security (MBS) market represents the largest single component of most popular global bond indices with a 33% market capitalization. The DB Liquid Mortgage-Backed Security Index aims to provide investors with a simple way to benchmark against the US Agency Mortgage market using the most liquid instruments available. The historical levels for the index have been calculated from 1 January Selection Rules The eligible list of bonds is comprised of the most liquid segments of the mortgage market designated TBA or To Be Announced. TBA collateral is generally cheapest to deliver into a TBA contract, much like deliverable futures contracts. The index aims to provide returns on pool vintages which are TBA (the cheapest to deliver). The DB Liquid Mortgage-Backed Security Index does not use the average prepayment speed for an entire agency/maturity/coupon combination, but designates a specific vintage year for each agency/maturity/coupon combination. The selected vintages are used to calculate the impact of prepayments over month-end. The index uses the following selection rules to determine the vintage year to be used for each agency/maturity/coupon combination, subject to oversight by the DB Index Quant group (DBIQ) in cases where this selection methodology may not produce collateral representative of TBA: In Step one, only the production year cohorts for the last six years (not including the current year) are considered eligible. For example in 2012, cohorts with production years in 2006,2007,2008,2009,2010 and 2011 are eligible In Step two, of the eligible cohorts in Step 1, only cohorts with a Remaining Principal Balance comprising at least 3% of the sum of the remaining principal balance of all 6 eligible cohorts are considered. In Step three, each agency/maturity/coupon combination is designated as a premium or discount bond, based on the price of the respective TBA contract as of the previous business day. If the corresponding TBA closes at or above a price of 100, it is designated a premium bond and if it closes below a price of 100, it is designated a discount bond. In the final step, for a premium bond, the production year of the cohort with the maximum CPR is chosen as the vintage year for the entire agency/maturity/coupon combination and for a discount bond, the production year of the cohort with the minimum CPR is chosen as the vintage year for the entire agency/maturity/coupon combination The first two rules are designed to use the most liquid, recent vintage as the TBA. The last rule is designed to select a vintage that is most representative of the agency/maturity/coupon combination according to the TBA market For each agency/maturity/coupon combination, rather than attempting to track individual vintage prices, which can be highly subjective, the index tracks only the TBA price. Weighting Methodology The index is rebalanced monthly on the last day of each month Each coupon is weighted according to the entire current outstanding balance of the coupon in the market, regardless of the production year. Index weighting is updated on the first business day of the month using the most recently available principal balance data. 2

3 Index Return Calculation Pricing of Index Security The index uses TBA prices to estimate the price of a generic MBS Index Security for t+0 settlement date. The market quoted price for a TBA is the price for the SIFMA settlement date. The quoted price reflects all the cash flows that the bond holder is entitled to after the SIFMA settlement date. For T+0 settlement date, the price should be adjusted to reflect all the cash flows that a bond holder is entitled to on T+0. Price of the MBS at time t adjusted for T+0 settlement Price of the MBS at time t for settlement at time t The survival ratio used in return calculation Accrued interest for MBS security for settlement at time. For more details see Appendix A Current day. It is a day in the m th month Beginning Market Value of Index Security Ending Market Value of Index Security The last day of the (m-1) th month The survival ratio used in return calculation. For more details see Appendix B The coupon rate for the MBS security Market value of the index security at the end of the period. Market value of the index security at the beginning of the period. Cash Component of Index Security The Cash Component of return for the index security is comprised of return due to Coupon Payment as well as Cash Pay down due to return of principal portion. The holder of record at the last day of month (m-1) is entitled to the coupon for month (m-1). The coupon for month (m-1) is officially paid on the first day of the month m. But the coupon is not received until the payment delay date. 3

4 12 January 2012 The month-to-date cash payment includes coupon payment and pay-down Coupon payment for date t Cash pay-down for date t Cash flow payment day in the m th month (The cash flow is for (m-1) th month) Daily repo rate. For more details see Appendix A Month-to-date Total Return of Index Security Month to Date Total Return of a Security in the index Index Month-to-date Total Return Market value of the i th index security at the beginning of the period. Month-to-date total return for the i th index security Number of index components Index Level Month-to-date total return for the index Index level for t 4

5 Appendix A Because of the conventions particular to the MBS market, in calculating the total return for MBS securities we need to take into account the following issues: 1. MBS pass-throughs settle once a month based on SIFMA schedules. The prices that are quoted in the market are for a settlement date that can be many days in the future. All DBIQ indices and iboxx indices use the T+0 or cash settlement convention. In our calculation for the DB Liquid MBS index, we will make adjustments to take this into account. 2. Because of the forward settlement of MBS, under certain circumstances there will be cash flow(s) that the purchaser of the bond is not entitled to if it is settled forward. However, the cash flow(s) should be accounted for if it is cash settled (T+0). 3. Although the holder of record of an MBS at the end of a month is entitled to the coupon and pay-down payment for the month, the payment is paid with a scheduled payment delay (15 days or 25 days). This payment delay needs to be adjusted for cash (T+0) settlement. Accrued Interest Current date. It is a day in the m th month Accrued interest for MBS security for settlement at time Number of days between the beginning of the month and time, The 1 st and last day of the m th month The coupon rate for the MBS security Repo Rate In our calculation, to adjust the prices and cash flows in future dates we discount them to present values using a repo rate. We use a generic MBS repo rate in our calculation. Daily repo rate Annual repo rate Number of days in a year for the repo day count convention. For Actual/360 day count, 5

6 12 January 2012 Appendix B: Survival Factor Calculations The survival ratio for each MBS security is the portion of the principal balance that is remaining after the scheduled and unscheduled principal payments have been accounted for in month m. Hence, the survival ratio is dependent on the prepayment speed for month m. We calculate the survival ratio from the prepayment information as below Then the survival ratio is: The scheduled remaining balance The percentage of remaining balance due to prepayment. the gross coupon rate of the MBS security the term of the MBS in months (i.e. for 30-year MBS N = 360 and for 15-year MBS N = 180 ) Weighted Average Maturity Prepayment Rate Single Month Mortality 6

7 Index Guide Disclaimers This document is intended for information only and does not create any legally binding obligations on the part of Deutsche Bank AG and/or its affiliates ( DB ). This document is intended to provide a summary of the index it purports to describe. No warranty or representation is made as to the correctness, completeness and accuracy of the information. Without limitation, this document does not constitute an offer, an invitation to offer or a recommendation to enter into any transaction. When making an investment decision, you should rely solely on the final documentation relating to the transaction. Products based on the index or indices described in this document may not be appropriate for all investors and before entering into any transaction you should take steps to ensure that you fully understand the transaction and have made an independent assessment of the appropriateness of the transaction in the light of your own objectives and circumstances, including the possible risks and benefits of entering into such transaction. Refer to your DB Sales person for product related information. For general information regarding the nature and risks of the proposed transaction and types of financial instruments please go to You should also consider seeking advice from your own advisers in making this assessment. If you decide to enter into a transaction with DB, you do so in reliance on your own judgment. Past performance is no indication of future results. This material was prepared by DBIQ. 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