======PSA Model======
The PSA Model (also known as the '[[Public Securities Association]] Prepayment Model') is an industry-standard benchmark used to estimate the speed at which homeowners are likely to pay off the mortgages within a [[mortgage-backed security]] (MBS). Homeowners prepay their loans for various reasons—selling their house, refinancing to a lower rate, or tapping into home equity. This prepayment activity is a massive variable for investors because it determines how quickly they get their principal back. Faster or slower-than-expected prepayments can dramatically alter the [[cash flow]] stream of an MBS, which in turn affects its yield and overall value. The PSA model doesn't predict the future, but it provides a standardized "speedometer" (e.g., 100 PSA, 200 PSA) that allows investors to compare different MBS products on an apples-to-apples basis and analyze the potential impact of [[prepayment risk]].
===== How Does the PSA Model Work? =====
The model's elegance lies in its simplicity. It establishes a baseline speed and then measures everything else relative to it.
==== The 100 PSA Benchmark ====
The heart of the model is the **100 PSA** speed, which serves as the fundamental baseline. It’s a simple, two-stage assumption about how prepayments will occur over the life of a new mortgage pool:
  * **The Ramp-Up:** For the first 30 months, the model assumes the annual prepayment rate starts low and grows steadily. It begins at 0.2% in the first month and increases by 0.2% each subsequent month. This reflects the "seasoning" process, as new homeowners are less likely to move or refinance immediately after taking out a loan.
  * **The Plateau:** After month 30, the prepayment rate is assumed to hit a ceiling and remain constant at 6% per year for the rest of the mortgage's life.
==== Faster or Slower? Interpreting PSA Speeds ====
Once you understand the 100 PSA baseline, interpreting other speeds is straightforward. They are simply multiples of the benchmark.
  * A **200 PSA** reading means prepayments are assumed to happen at //twice// the 100 PSA rate. During the ramp-up, the rate would increase by 0.4% each month (0.2% x 2), and the plateau would be a constant 12% per year (6% x 2).
  * A **50 PSA** reading means prepayments are assumed to occur at //half// the 100 PSA rate. The ramp-up would be 0.1% per month (0.2% x 0.5), and the plateau would be 3% per year (6% x 0.5).
This system provides a quick, standardized language for discussing and comparing prepayment speeds. A higher PSA number signals faster expected prepayments, meaning an investor will likely receive their principal back sooner.
===== Why Should a Value Investor Care About PSA? =====
For a value investor, the price you pay determines your return. The PSA model is crucial because prepayment speed radically changes the value proposition of an MBS, particularly when dealing with a [[Premium Bond]] or a [[Discount Bond]].
==== Impact on Cash Flow and Yield ====
How quickly you get your money back can either make or break your investment.
  * **For a Premium Bond:** Imagine paying $110 for a bond with a $100 face value to capture its juicy, high-interest payments. In this case, fast prepayments (a high PSA) are your enemy. You get your $100 principal back sooner than expected, which cuts short the time you can collect those above-market interest payments. This accelerates your premium loss and crushes your actual [[yield-to-maturity]]. This is a classic example of [[reinvestment risk]]—being forced to reinvest your capital at lower prevailing [[interest rates]].
  * **For a Discount Bond:** Now, imagine paying just $90 for that same $100 bond. Fast prepayments (a high PSA) are your best friend! You receive the full $100 principal back sooner than planned, which means your $10 gain is realized much more quickly. This provides a handsome boost to your overall yield.
Understanding PSA helps a value investor avoid overpaying for premium securities in a falling-rate environment and spot potential opportunities in discounted ones.
==== A Tool, Not a Crystal Ball ====
While powerful, the PSA model is just a standardized assumption. //It is not a prediction.// Real-world prepayments are messy and influenced by many factors the simple model ignores:
  * **Economic Health:** In a booming economy with rising home prices, people may use "cash-out" refinances, boosting prepayments even if rates aren't falling.
  * **Rate "Burnout":** After a major refinancing wave, the remaining mortgage holders are often those who are unable or unwilling to refinance. Prepayments can then slow dramatically, even if rates fall further.
  * **Borrower Psychology:** Human behavior is never perfectly predictable.
A savvy value investor uses PSA speeds as a critical input for analysis, not a final answer. They stress-test their assumptions by considering what might happen if prepayments come in much faster or slower than the market expects. This is where the hunt for a [[margin of safety]] comes in—buying an asset at a price that offers protection even if the future doesn't unfold exactly as the models suggest.