Book 4_Fixed_READING 67_MORTGAGE-BACKED-SECURITY-_MBS_-INSTRUMENT-AND-MARKET-FEATURES

Question 1

Prepayment risk

Answer 1

refers to uncertainty about the timing of the principal cash flows from an MBS.

Question 2

Contraction risk

Answer 2

is the risk that loan principal will be repaid more rapidly than expected, typically when interest rates have decreased

Question 3

Extension risk

Answer 3

the risk that loan principal will be repaid more slowly than expected, typically when interest rates have increased.

Question 4

Time tranching

Answer 4

can be used to distribute prepayment risk across the tranches of an MBS

Question 5

The loan-to-value ratio (LTV)

Answer 5

the percentage of the value of the real estate collateral that is loaned. Lower LTVs indicate less credit risk.

Question 6

The debt-to-income ratio (DTI)

Answer 6

the size of the monthly debt payments of the borrower relative to their monthly pretax gross income. Lower DTIs indicate lower credit risk.

Question 7

Agency residential mortgage-backed securities (RMBSs)

Answer 7

• Are guaranteed and issued by the federal government or a government-sponsored enterprise
• Non-agency RMBSs are issued by private companies and may be backed by riskier nonconforming subprime loans

Question 8

Key characteristics of RMBS pass-through securities

Answer 8

• The pass-through rate (the coupon rate on the RMBS)
• The weighted average maturity (WAM)
• Weighted average coupon (WAC) of the underlying pool of mortgages.

Question 9

Collateralized mortgage obligations (CMOs)

Answer 9

• Are collateralized by RMBSs or pools of mortgages.
• CMOs are structured with tranches that have different exposures to prepayment risks.

Question 10

In a sequential pay CMO, all scheduled principal payments and prepayments are paid to each tranche in sequence until that tranche is paid off.

Answer 10

The first tranche to be paid principal has the most contraction risk, and the last tranche to be paid principal has the most extension risk.

Question 11

A planned amortization class CMO

Answer 11

has PAC tranches that receive predictable cash flows as long as the prepayment rate remains within a predetermined range, and support tranches that have more contraction risk and more extension risk than the PAC tranches.

Question 12

Other types of CMO tranches

Answer 12

Z-tranches, principal-only tranches, interest only tranches, floating-rate tranches, and residual tranches

Question 13

Commercial mortgage-backed securities (CMBSs)

Answer 13

• Are backed by mortgages on income-producing real estate properties
• Because commercial mortgages are nonrecourse loans, analysis of CMBSs focuses on credit risk of the properties.
• CMBSs are structured in tranches with credit losses absorbed by the lowest-priority tranches in sequence.

Question 14

Call (prepayment) protection in CMBSs includes

Answer 14

• Loan-level call protection such as prepayment lockout periods, defeasance, prepayment penalty points, and
• CMBSlevel call protection provided by lower-priority tranches.

Question 15

CMBS loans

Answer 15

are more likely to be partially amortizing than residential loans, leading to balloon risk.

Question 16

Ratios used to analyze the credit risk of a commercial mortgage

Answer 16

include the debt service coverage ratio and the loan-to-value ratio