Deck 8: Basics of Residential Mortgage Backed Securities

Question 1

What is a Collateralized Mortgage Obligation (CMO)?

Answer 1

Collateralized Mortgage Obligations are securities derived from MBS that are structured with different risk-return characteristics in order to appeal to different investors' clienteles.

Question 2

What is an Interest Only (IO) strip?

Answer 2

Interest Only strips are securities that receive all interest payments from the underlying pool of assets and none of the principal.

Question 3

What does securitization mean?

Answer 3

Securitization is a way of diversifying risk, in which several institutions pool similar assets together in order to sell them to investors.

Question 4

What does CPR stand for? What does it measure?

Question 5

What happens to the value of an IO if interest rates fall? 34

Question 6

Do MBS have negative convexity? Why?

Question 7

What is negative convexity?

Question 8

Price the previous mortgage, assuming that the term structure of interest rates is ?at at 5%.

Question 9

What does 100% PSA mean? How does it compare against 50% PSA and 200% PSA?

Question 10

Prior to 2008, under what assumption were mortgages backed by Fan- nie Mae and Freddie Mac considered to be 'safe' investments? Was this assumptions well founded?

Question 11

What is the TBA market?

Question 12

When is it assumed that the prepayment option will be exercised, if mort- gage owners act rationally?

Question 13

What is a Principal Only (PO) strip?

Question 14

Fill data on the following tables representing the cash flow of a 2-year mortgage that is paid semiannually with principal 1,000 and interest 5%:

Question 15

What is a tranche?

Question 16

What is a Special Purpose Vehicle (SPV)?

Question 17

What is a Planned Amortization Class (PAC)?

Question 18

What is a prepayment option?

Question 19

What is a mortgage?

Question 20

What is the main difference between a pool of mortgages and a pass- through security from the same pool?

Question 21

What happens to the value of a PO if interest rates fall?