Agency debt Flashcards
What does GNMA stand for?
Government National Mortgage Association
What types of mortgages does Ginnie Mae buy?
Federal Housing Administration and Department of Veterans Affairs mortgages
How does GNMA generate pass-through certificates?
By auctioning pooled mortgages to private lenders
What is the minimum size of a GNMA certificate sold to an individual investor?
$25,000
Why are yield quotes for GNMA certificates based on a 12-year prepayment assumption?
Because few mortgages last the full term due to refinancing and early payoffs
Where do GNMA certificates trade?
Over the counter
What risk are GNMA certificates subject to?
Reinvestment rate risk
Fill in the blank: The GNMA auctions mortgages to private lenders that pool them to create _______.
pass-through certificates
True or False: GNMA certificates are typically bought and sold on a stock exchange.
False
True or False: Freddie Mac was created to promote the development of a secondary mortgage market.
True
Fill in the blank: The primary purpose of Freddie Mac is to provide liquidity, stability, and __________ to the mortgage market.
affordability
Multiple Choice: What type of organization is Freddie Mac? A) Government agency B) Private corporation C) Non-profit organization D) International organization
A) Government agency
True or False: FHLMC creates pass-through certificates to help homebuyers with their mortgage interest.
True
Fill in the blank: Like GMNA, FHLMC uses _______ certificates as a mechanism to pass homebuyers’ interest.
pass-through
What is the primary purpose of pass-through certificates created by FHLMC?
To pass homebuyers’ interest and principal payments to investors.
Multiple Choice: Which of the following is a mechanism for passing interest and principal to investors?
Pass-through certificates
True or False: Fannie Mae competes with the Federal Home Loan Mortgage Corporation (FHLMC) for investor money.
True
Fill in the blank: FNMA is commonly known as ______.
Fannie Mae
Which organization is primarily known for securitizing mortgage loans in the United States?
The Federal National Mortgage Association (FNMA) or Fannie Mae
What is the primary purpose of Fannie Mae in the mortgage market?
To provide liquidity, stability, and affordability to the mortgage market.
True or False: FNMA is fully owned by the government.
False
Fill in the blank: FNMA is a government-sponsored corporation that is owned entirely by ______.
private entities
What is the primary difference between FNMA and FHLMC?
FNMA is owned entirely by private entities, while FHLMC has different ownership structures.
Multiple Choice: Which of the following is true about FNMA? A) It is a government agency B) It is a government-sponsored corporation C) It is a non-profit organization D) It is a private company.
B) It is a government-sponsored corporation
What is an embedded call option in mortgage pass-throughs?
A prepayment option granted to the mortgagee
What happens when interest rates fall regarding mortgage refinancing?
Individuals are likely to refinance their mortgages at lower rates
How do pass-throughs like those of Ginnie Mae, Fannie Mae, and Freddie Mac behave during declining interest rates?
They may exhibit limited or no price increases
True or False: Investors expect homeowners to refinance high-rate mortgages when interest rates decrease.
True
Fill in the blank: Mortgage pass-throughs may exhibit limited price increases during periods of _______.
declining interest rates
What is the relationship between falling interest rates and prepayments?
If interest rates fall sufficiently, prepayments rise.
This phenomenon is referred to as prepayment risk.
What is prepayment risk?
Prepayment risk is the risk of an increase in prepayments when interest rates fall.
This can affect the returns on investments like mortgage-backed securities.
How do yields on pass-throughs compare to straight government bonds?
Yields on pass-throughs tend to be somewhat higher than on straight government bonds of the same expected maturity.
This is due to the additional risks associated with prepayments.
What risk do investors face when they receive money from prepayments?
Investors encounter reinvestment rate risk.
This occurs because reinvestments are made when interest rates have declined.
Fill in the blank: When interest rates decline, the risk associated with reinvestments is known as _______.
reinvestment rate risk
What is the opposite of prepayment risk?
Extension risk
Extension risk occurs when expected prepayments slow down, particularly when interest rates increase.
What causes extension risk?
Slowing down of expected prepayments when interest rates increase
This situation extends the average life of mortgages.
What happens to the average life of mortgages when interest rates increase?
It extends
This extension leads to delays in the receipt of expected principal.
What is the impact of extension risk on the rate of return?
It decreases
A delay in receiving expected principal results in a lower rate of return on the security.
Fill in the blank: Extension risk results from the _______ of expected prepayments when interest rates increase.
slowing down
True or False: Extension risk leads to an increase in the average life of mortgages.
True
This is a direct consequence of the slowing down of expected prepayments.
The anatomy of a Mortgage-backed pass through security.
Erosion of capital base: If an investor doesn’t reinvest the principal portion of these monthly payments, their initial investment capital gradually decreases over time..
This is different from a traditional bond where the entire principal is returned at maturity.
Impact on future returns: As the principal balance decreases, so does the base on which interest is earned.
This means that if an investor spends the principal portion of the payments rather than reinvesting it, they’ll receive progressively smaller interest payments over time
Unknowing loss: Many investors might not realize this is happening if they’re not closely tracking their investments. They might perceive all of the monthly payment as “income” when in fact part of it is a return of their own capital.
Long-term consequences: Over the life of the security, this can lead to a significant reduction in the investor’s capital base, potentially leaving them with less money invested than they originally intended
Interest income from Fannie Mae, Freddie Mac and Ginnie Mae securities is fully taxable at the federal level
- Principal payments, representing return of capital, are not taxed as income.
Exempt from state and local taxes.
- Interest income from these entities is generally exempt from state and local taxes. Mm.
What type of investors might consider U.S. agency bonds?
Investors who want a current yield that is higher than those available on T-bills, T-notes, or T-bonds.
Are U.S. agency bonds guaranteed by the U.S. government?
Typically not, with the exception of GNMA securities.
Fill in the blank: U.S. agency bonds might be appropriate for investors who want a current yield that is higher than those available on _______.
[T-bills, T-notes, or T-bonds]
True or False: All agency issues are guaranteed by the U.S. government.
False
What is the exception to the guarantee of agency issues?
GNMA securities.
Fannie Mae and Freddie Mac were delisted from the New York Stock Exchange (NYSE)
Conservatorship status: Both Fannie Mae and Freddie Mac had been operating under conservatorship since September 2008, with significant government support
What is Ginnie Mae’s role in the MBS process?
