Chapter 9 - Real Estate Fixed-Income Investments

Question 1

Keyword ‘Balloon payment’

Answer 1

Large scheduled future payment

Question 2

Keyword ‘Collateralized mortgage obligations (CMOs)’

Answer 2

Extend the MBS mechanism to create different bond classes called tranches that have different priorities to receiving cash flows and therefore have different risks.

Question 3

Keyword ‘Commercial mortgage loans’

Answer 3

Largely taken out by corporations or other legal entities. The risk of mortgages on commercial properties often focuses on the rental income generated by the property that can be used to make the mortgage payments.

Question 4

Keyword ‘Commercial mortgage-backed securities (CMBS)’

Answer 4

Mortgage-based securities with underlying collateral pools of commercial property loans.

Question 5

Keyword ‘Conditional prepayment rate (CPR)’

Answer 5

Annualized % of a mortgage’s remaining principal value that is prepaid in a particular month.

Question 6

Keyword ‘Contraction risk’

Answer 6

Dispersion in economic outcomes caused by uncertainty in the longevity, especially decreased longevity, of cash flow streams.

Question 7

Keyword ‘Covenants’

Answer 7

Promises made by the borrower to the lender and can require the borrower to maintain the property and continue to meet specified financial conditions.

Question 8

Keyword ‘Cross-collateral provision’

Answer 8

When the collateral for one loan is also utilized for some other loan.

Question 9

Keyword ‘Debt service coverage ratio (DSCR)’

Answer 9

Concerned with the coverage of all loan payments, including the amortization of the loan.

Question 10

Keyword ‘Default risk’

Answer 10

Dispersion in economic outcomes due to the actual or potential failure of a borrower to make scheduled payments.

Question 11

Keyword ‘Equity REITs’

Answer 11

Invest predominantly in equity ownership within the private RE market

Question 12

Keyword ‘Extension risk’

Answer 12

Dispersion in economic outcomes caused y uncertainty in the longevity, especially increased longevity, of cash flow streams.

Question 13

Keyword ‘Fixed-rate mortgages’

Answer 13

Fixed-rate constant payment, fully amortized loan has equal monthly payments throughout the life of the loan. Value of loan subject to interest rate and inflation risk.

Question 14

Keyword ‘Floating-rate tranches’

Answer 14

A floating-rate collateralized mortgage obligation (CMO) tranche whose coupon rate is determined by a formula based on an interest-rate index such as LIBOR.

Question 15

Keyword ‘Hybrid REITs’

Answer 15

REITs that invest in both markets (mortgage and equity) and do not comply with either 75% cutoff.

Question 16

Keyword ‘Idiosyncratic prepayment factors’

Answer 16

Factors other than interest rates or other systematic factors that affect prepayment decisions. Prevent the specification of a precise relationship between unscheduled prepayment and interest rate levels, and option pricing models that assume exercise behaviour based solely on interest rates should not be used.

Question 17

Keyword ‘Index rate’

Answer 17

Variable interest rate used in determination of the mortgage’s stated interest rate

Question 18

Keyword ‘Interest coverage ratio’

Answer 18

Property’s net operating income divided by the loan’s interest payments. It allows the lender to analyse the level of protection they have in terms of the borrower’s ability to service the debt from the property’s operating income.

Question 19

Keyword ‘Loan-to-value (LTV) ratio’

Answer 19

Ratio of the amount of the loan to the value (either market or appraised) of the property.

Question 20

Keyword ‘Margin rate’

Answer 20

Spread by which the stated mortgage rate is set above the index rate

Question 21

Keyword ‘Mortgage’

Answer 21

Loan secured by a property

Question 22

Keyword ‘Mortgage REITs’

Answer 22

Mortgage REITs invest predominantly in RE based debt

Question 23

Keyword ‘Mortgage-backed securities (MBS)’

Answer 23

Type of asset-backed security that is secured by a mortgage or pool of mortgages.

Question 24

Keyword ‘Option adjustable-rate mortgage loans’

Answer 24

Adjustable-rate mortgage that provides borrowers with the flexibility to make one of several possible payments on their mortgage every month.

Question 25

Keyword ‘Prepayment option’

Answer 25

Viewed as a call option on the value of the debt, the option may also be viewed as a put option on interest rates.

Question 26

Keyword ‘PSA benchmark’

Answer 26

Public Securities Association (PSA) established a benchmark of prepayment speed titled the PSA Prepayment Benchmark that is based on the CPR (conditional prepayment rate)

Question 27

Keyword ‘Recourse’

Answer 27

Recourse includes how the loan is secured, such as the potential ability of the lender to take possession of the property in the event of a default and the potential ability of the lender to pursue recovery from the borrower’s other assets.

Question 28

Keyword ‘REITs (Real estate investment trusts)’

Answer 28

Entity structured much like a traditional operating corporation except that the assets of the entity are almost entirely RE.

Question 29

Keyword ‘Residential mortgage loans’

Answer 29

Typically taken out by individual households that generate no explicit rental income if the houses are owner occupied. Therefore, the credit risk of residential mortgages depends on the borrowers income and financial position, in addition to the characteristics of the property.

Question 30

Keyword ‘Residential mortgage-backed securities (RMBS)’

Answer 30

Mortgage-based securities with underlying collateral pools of residential property loans (usually insured).

Question 31

Keyword ‘Sequential-pay collateralized mortgage obligation’

Answer 31

Simplest form of Collateralized mortgage obligations

Question 32

Keyword ‘Subprime mortgages’

Answer 32

Uninsured mortgages with borrowers of relatively high credit risk

Question 33

Keyword ‘Tranche’

Answer 33

Security class that is created, typically with other tranches, in the structuring or division of an asset’s cash flows, risks, and returns.

Question 34

Keyword ‘Unscheduled principal payments’

Answer 34

Payments above and beyond the scheduled mortgage payments

Question 35

Keyword ‘Variable-rate mortgages’

Answer 35

Also known as adjustable-rate mortgages (ARM). Interest rate is periodically adjusted by the lender, generally to reflect changes in underlying short-term market interest rates.

Question 36

True or false: When interest rates decline, the life of junior tranches will be extended, thereby extending the expected life of the tranche further than originally expected.

Answer 36

False

Question 37

Which of the following alternatives is least likely to be a factor that influences prepayment rates: the current level of mortgage rates relative to the rates being charged on the loans in the pool, the path that mortgage rates have followed to arrive to the current interest rate level, the type of mortgages in the pool, or the weather of the geographical area from which the pool of mortgages originates?

Answer 37

The weather