Mortgage-Backed Securities Flashcards
MBS = ?
mortgage backed securities
what is a traditional mortgage loan?
an individual getting a mortgage and the bank will receive interest and principal payment on the maturity date
mortgage = ?
a real estate loan
mortgage backed securities = ?
a bank pools together several mortgage loans, packages them up and sells them to investment banks to raise capital to issue more mortgage loans
after an MBS has been outsourced from a commercial bank to an investment bank, who receives the payments?
the investment bank gets the payments
what is a commercial bank’s incentive for doing an MBS deal with an investment bank?
shift risk (risk of default no longer impacts them)
free up capital (from n/p to cash)
receive cash (to issue more loans & sell more CDO’s)
what does the investment bank do with the MBS?
they outsource their rights to the interest/coupon payments and principal payments to another entity in which investors can buy shares
is a mortgage backed security a debt security or a derivative security?
debt security
an MBS is essentially a bond, therefore it’s classed as a debt security
CDO = ?
collateralised debt obligation
an obligation to pay a debt that is collateralised with a real asset (e.g. a house in the case of an MBS)
how do CDO’s and MBS’s link?
an MBS is a CDO that is solely backed by mortgage loans
if a homeowner defaults on their mortgage payment, the issuer of the loan receives their property
derivative security = ?
a security that derives its value from another asset to manage risk
e.g., swaps, futures
what are tranches?
french for ‘a portion of something’
different categories for CDO’s representing varying risk/quality levels
what are the three tranches for CDO’s?
senior (best quality)
mezzanine (middle)
equity (most risky)
what does each tranche level indicate?
the higher the tranche, the less likely of default
the lower the tranche, the more likely a default is to occur
