Lecture 14: Secondary Mortgage Market II

Question 1

Mortgage Pass-Through Securities (MPTs)
Ownership interest in a pool of mortgages
Trustee is owner of the mortgages in the pool
Cash flows (i.e., principal and interest minus servicing and guarantee fees) are distributed, or “passed through”, to security holders

GNMA’s guarantee for a full and timely payment of principal and interest for mortgage-backed securities

Answer 1

Mortgage Pass-Through Securities (MPTs)
Ownership interest in a pool of mortgages
Trustee is owner of the mortgages in the pool
Cash flows (i.e., principal and interest minus servicing and guarantee fees) are distributed, or “passed through”, to security holders

GNMA’s guarantee for a full and timely payment of principal and interest for mortgage-backed securities

Question 2

Collateralized Mortgage Obligations
As with MBB, CMOs are debt instrument issued using a pool of mortgages as collateral.
Similarly, mortgage pool still owned by issuer.
Like MPT and MPTB, CMO is a pass-through security of interest and principal
CMO: multiple classes of securities issued
Different maturity classes (e.g., 3-, 5-, or 7-years)
Different priority for payment (e.g., tranches)
Meet the investment needs of various investors
=> CMO: “???, mortgage pay-through security”!!

Answer 2

Collateralized Mortgage Obligations
As with MBB, CMOs are debt instrument issued using a pool of mortgages as collateral.
Similarly, mortgage pool still owned by issuer.
Like MPT and MPTB, CMO is a pass-through security of interest and principal
CMO: Multiple classes of securities issued
Different maturity classes (e.g., 3-, 5-, or 7-years)
Different priority for payment (e.g., tranches)
Meet the investment needs of various investors
=> CMO: “Multiple security class, mortgage pay-through security”!!

Question 3

Mortgage Pay-Through Bonds
Containing elements of both MBB and MPT
Like MBB, debt obligation of issuer, who retains ownership of the mortgage pool; with a coupon rate or zero-coupon basis
Like MPT, cash flows from the pool (i.e., interest and principal) are pass-through to security holders.

Credit rating depends on three things:

• Riskiness of mortgages
• Extent of ??
• Whether or not there are US gov’t bonds or agency obligations as excess collateral

Answer 3

Mortgage Pay-Through Bonds
Containing elements of both MBB and MPT
Like MBB, debt obligation of issuer, who retains ownership of the mortgage pool; with a coupon rate or zero-coupon basis
Like MPT, cash flows from the pool (i.e., interest and principal) are pass-through to security holders.

Credit rating depends on three things:

• Riskiness of mortgages
• Extent of over collateralization
• Whether or not there are US gov’t bonds or agency obligations as excess collateral

Question 4

Commercial Mortgage-Backed Securities (CMBS)
Similar in form to residential MBSs (RMBS)
Default risk is significantly ?
It is secured by mortgages on ‘income-producing’ properties
If tenants default on lease payments or if the rents generally decline, the income used to make mortgage payments will become jeopardized.

Assets in mortgage pool
Often interest-only
Little or no principal payments until mortgages mature!

Answer 4

Commercial Mortgage-Backed Securities (CMBS)
Similar in form to residential MBSs (RMBS)
but Default risk is significantly higher!!
It is secured by mortgages on ‘income-producing’ properties
If tenants default on lease payments or if the rents generally decline, the income used to make mortgage payments will become jeopardized.

Assets in mortgage pool
Often interest-only
Little or no principal payments until mortgages mature!

Question 5

Two major classes of CMBS offering:
Senior Tranche (A piece): ? ? of claims
Subordinate Tranche (B piece)

Answer 5

Two major classes of CMBS offering:
Senior Tranche (A piece): highest priority of claims
Subordinate Tranche (B piece)

Question 6

Credit Enhancements (to reduce default risk!):
Issuer of 3rd party guarantee
Surety bonds and letters of credit
Advance payment agreements
Loan substitutions and repurchase agreements
Lease assignments
??
Cross-collateralization and cross-default

Answer 6

Credit Enhancements (to reduce default risk!):
Issuer of 3rd party guarantee
Surety bonds and letters of credit
Advance payment agreements
Loan substitutions and repurchase agreements
Lease assignments
Over collateralization
Cross-collateralization and cross-default

Question 7

Which of the following are the major challenges in pricing mortgage pass-through securities (MPTs)?
A.
No specific maturity

B.
No well-defined cash flow

C.
Various assumptions on the level of prepayment risk

D.
All of the above

Answer 7

Which of the following are the major challenges in pricing mortgage pass-through securities (MPTs)?

Selected Answer:
CorrectD.
All of the above

Answers:
A.
No specific maturity

B.
No well-defined cash flow

C.
Various assumptions on the level of prepayment risk

Correct D.
All of the above

Question 8

The prices of mortgage pass-through securities are:

A.
Unaffected by changes in interest rates

B.
Related positively to changes in interest rates

C.
More sensitive to declines in interest rates and less sensitive to increases in interest rates

D.
Less sensitive to declines in interest rates and more sensitive to increases in interest rates

Answer 8

The prices of mortgage pass-through securities are:

Selected Answers:
CorrectD.
Less sensitive to declines in interest rates and more sensitive to increases in interest rates

Answers:
A.
Unaffected by changes in interest rates

B.
Related positively to changes in interest rates

C.
More sensitive to declines in interest rates and less sensitive to increases in interest rates

CorrectD.
Less sensitive to declines in interest rates and more sensitive to increases in interest rates

Question 9

Compared to mortgage pass-through securities (MPTs), mortgage-backed bonds (MBBs) should be priced to provide:

A.
Lower yield, because of lower prepayment risk

B.
Higher yield, because of higher prepayment risk

C.
The same yield, because of the equivalent level of prepayment risk

D.
None of the above

Answer 9

Compared to mortgage pass-through securities (MPTs), mortgage-backed bonds (MBBs) should be priced to provide:

Selected Answer:
CorrectA.
Lower yield, because of lower prepayment risk

Answers:
CorrectA.
Lower yield, because of lower prepayment risk

B.
Higher yield, because of higher prepayment risk

C.
The same yield, because of the equivalent level of prepayment risk

D.
None of the above

Question 10

The credit rating of mortgage pay-through bonds (MPTBs) depends on:

A.
Riskiness of mortgages

B.
The extent of over-collateralization

C.
Whether or not there are US government bonds as excess collateral

D.
All of the above

Answer 10

The credit rating of mortgage pay-through bonds (MPTBs) depends on:

Selected Answer:
CorrectD.
All of the above

Answers:
A.
Riskiness of mortgages

B.
The extent of over-collateralization

C.
Whether or not there are US government bonds as excess collateral

CorrectD.
All of the above

Question 11

Which of the following is the major difference between residential MBSs (RMBS) and the commercial mortgage-backed securities (CMBS)?
A.
The default risk of RMBS is significantly higher

B.
The default risk of CMBS is significantly higher

C.
The assets in mortgage pool of RBMS are often interest-only mortgages

D.
The assets in mortgage pool of CBMS are often repayment mortgages

Answer 11

Which of the following is the major difference between residential MBSs (RMBS) and the commercial mortgage-backed securities (CMBS)?

Selected Answer:
CorrectB.
The default risk of CMBS is significantly higher

Answers:
A.
The default risk of RMBS is significantly higher

CorrectB.
The default risk of CMBS is significantly higher

C.
The assets in mortgage pool of RBMS are often interest-only mortgages

D.
The assets in mortgage pool of CBMS are often repayment mortgages