Question 1

Why are the class C bonds of a CMO highly attractive to insurance companies and pension funds?
A)Because of their ability to offer perfect prepayment protection.
B)Because of the shortest average life with a minimum of prepayment protection.
C)Because of their long expected duration.
D)Because they are basically zero coupon bonds and hence carry a minimum amount of risk.

Accepted Answer

Class C bonds of a CMO are attractive to insurance companies and pension funds because they have a long expected duration, which aligns well with the long-term liabilities of these institutions.

Question 2

An FI funds a $5 million residential mortgage in 2017 by allocating capital and by issuing demand deposits.The mortgage represents a loan-to-value of 70 percent.The demand deposits have a reserve requirement of 10 percent and a deposit insurance premium of 23 basis points.

What is the deposit insurance premium on the demand deposits issued to fund the mortgage?
A)$11,756.
B)$12,778.
C)$11,500.
D)$1,150.

Accepted Answer

Deposit insurance premium is 23 basis points
$5,555,555 F1F1F1S1F1F1F10 0.0023 = $12,777.77.

Question 3

Which of the following best explains the term burn-out factor?
A)The percent of mortgage contract that is transferred from the seller to the buyer of a house.
B)The required interest spread of a pass-through security over a treasury when prepayment risk is taken into account.
C)The aggregate percent of the mortgage pool that has been prepaid prior to the month under consideration.
D)A mortgage-backed bond issued in multiple classes or tranches.

Accepted Answer

Burn-out factor refers to the percentage of the outstanding mortgage pool that has been prepaid. It is called the "burn-out" factor because a mortgage loan that has been paid off or prepaid reduces the size of the mortgage pool, which means that the remaining loans have a larger share of the pool. This reduces the prepayment risk for investors in mortgage-backed securities.

Question 4

These bonds of a CMO have some prepayment protection and expected durations of five to seven years depending on the level of interest rates and are primarily purchased by pension funds and life insurance companies.
A)Class A bonds.
B)Class R bonds.
C)Class C bonds.
D)Class Z bonds.
E)Class B bonds.

Accepted Answer

Class B bonds of a Collateralized Mortgage Obligation (CMO) offer some level of prepayment protection and have expected durations that make them appealing to investors like pension funds and life insurance companies, who are typically looking for medium-term investments that align with their liabilities and investment strategies.

Question 5

An FI funds a $5 million residential mortgage in 2017 by allocating capital and by issuing demand deposits.The mortgage represents a loan-to-value of 70 percent.The demand deposits have a reserve requirement of 10 percent and a deposit insurance premium of 23 basis points.

What amount of demand deposits are needed to fund the mortgage?
A)$5,500,000.
B)$400,000.
C)$5,555,555.
D)$500,000.

Accepted Answer

The answer of An FI funds a $5 million residential...

Question 6

Why are the regular GNMA pass-through not very attractive to insurance companies and pension funds seeking long-term duration assets to match their long-term duration liabilities?
A)Because of their short expected duration.
B)Because these bonds have the shortest average life with a maximum of prepayment protection.
C)Because they are zero coupon bonds and hence carry maximum amount of risk.
D)Because of their failures to offer prepayment protection.

Accepted Answer

The answer of Why are the regular GNMA pass-through not...

Question 7

Which of the following is NOT true of an R class CMO issue?
A)It is treated as "garbage class."
B)It is a high-risk investment class.
C)It gives the investor the rights to the over-collateralization and reinvestment income on the cash flows in the CMO trust.
D)Returns increase when interest rates increase.
E)It has a positive duration.

Accepted Answer

The answer of Which of the following is NOT true...

Question 8

What is defined as the sum of the products of the time when principal payments are received and the amount of principal received all divided by total principal outstanding?
A)Weighted-average life.
B)Burn-out factor.
C)Degree of collateralization.
D)Option-adjusted spread.

Accepted Answer

The given definition is of weighted-average life, which is a measure of the expected life of an asset or security based on the timing and amount of received principal payments.

Question 9

One hundred identical mortgages are pooled together into a pass-through security.Each mortgage has a $150,000 principal,a fixed annual interest rate of 8 percent (paid monthly),and is fully amortized over a term of 30 years.

What is the monthly payment on the mortgage pass-through?
A)$100,000.
B)$110,065.
C)$12,000.
D)$12,000,000.

Accepted Answer

To find the monthly payment on a mortgage, we can use the following formula:

PMT = P*r*(1 + r)^n / [(1 + r)^n - 1]

Where PMT is the monthly payment, P is the principal ($150,000), r is the monthly interest rate (8%/12 = 0.006667), and n is the total number of monthly payments (30 years * 12 months = 360).

PMT = 150000 * 0.006667 * (1 + 0.006667)^360 / [(1 + 0.006667)^360 - 1]
PMT ≈ $1,100.65

To find the monthly payment on the mortgage pass-through, we simply multiply the monthly payment of one mortgage by the total number of mortgages:

Monthly payment on mortgage pass-through = 100 * $1,100.65
Monthly payment on mortgage pass-through ≈ $110,065.

Therefore, the best answer is (B) $110,065.

Question 10

In regard to a CMO,which of the following bonds have the shortest average life with a minimum of prepayment protection?
A)Class A bonds.
B)Class B bonds.
C)Class C bonds.
D)Class Z bonds.

Accepted Answer

Class A bonds in a CMO structure typically have the shortest average life because they are the first to receive principal payments, including prepayments, which means they have minimal prepayment protection.

Question 11

Why do garbage class bonds often have a negative duration?
A)The value of the returns in this bond class increases when interest rates increase.
B)It gives the rights to collateralization.
C)Bond values fall with interest rate increases.
D)It gives rights to reinvestment income on the cash flows in the CMO trust.

Accepted Answer

Garbage class bonds, often associated with collateralized mortgage obligations (CMOs), can have a negative duration because their value increases when interest rates rise, contrary to typical bonds. This is due to the structure of these bonds, where rising rates can lead to faster prepayments and higher reinvestment rates.

Question 12

Which of these CMO bond issues has characteristics of both a zero-coupon bond and a regular bond?
A)Class A bonds.
B)Class B bonds.
C)Class C bonds.
D)Class Z bonds.

Accepted Answer

Class Z bonds are typically structured as zero-coupon bonds, meaning that they do not make any periodic interest payments. However, they also have characteristics of regular bonds because they have a maturity date at which the issuer must repay the principal amount of the bond.

Question 13

A claim to the present value of the interest payments made by the mortgage holders in a GNMA pool is
A)a CARS.
B)an IO strip.
C)a CARD.
D)a PO strip.

Accepted Answer

An IO (Interest-Only) strip represents a claim to the interest payments made by the mortgage holders in a GNMA pool.

Question 14

Mortgage-backed bonds (MBB)differ from pass-through and CMOs in which of the following ways?
A)The MBB bondholders have a junior claim to assets of the FI.
B)There is no direct link between the cash flow on the mortgages backing the bond and the interest and principal payments on the MBB.
C)The assets backing a MBB issue are normally removed from the balance sheet of the FI.
D)Tranches of a MBB are treated equally with respect to prepayments on mortgages backing the bond issue.

Accepted Answer

Unlike pass-through and CMOs, there is no direct link between the cash flow on the mortgages backing the bond and the interest and principal payments on the MBB. MBB bondholders have a senior claim to assets of the FI, and tranches of a MBB may be treated differently with respect to prepayments on mortgages backing the bond issue. The assets backing a MBB issue may or may not be removed from the balance sheet of the FI, depending on the structure of the bond.

Question 15

Which of the following is true concerning an assumable mortgage?
A)The aggregate percent of the mortgage pool that has been prepaid prior to the month under consideration.
B)The mortgage contract is transferred from the seller to the buyer of a house.
C)The required interest spread of a pass-through security over a treasury when prepayment risk is taken into account.
D)A mortgage-backed bond issued in multiple classes or tranches.

Accepted Answer

An assumable mortgage is a type of mortgage that can be transferred from the seller of a home to the buyer. This means that the buyer can take over the existing mortgage contract, rather than having to obtain a new mortgage. This can be beneficial for buyers if the interest rate on the assumable mortgage is lower than the current market rate.

Question 16

An FI funds a $5 million residential mortgage in 2017 by allocating capital and by issuing demand deposits.The mortgage represents a loan-to-value of 70 percent.The demand deposits have a reserve requirement of 10 percent and a deposit insurance premium of 23 basis points.

What is the minimum capital requirement on the mortgage in order for the institution to be adequately capitalized?
A)$0.
B)$400,000.
C)$200,000.
D)$500,000.

Accepted Answer

The answer of An FI funds a $5 million residential...

Question 17

Identify the residual class of a CMO that gives the owner the right to any remaining collateral in the trust after all other bond classes have been retired plus any reinvestment income earned by the trust.
A)Class A bonds.
B)Class B bonds.
C)Class C bonds.
D)Class Z bonds.
E)Class R bonds.

Accepted Answer

Class R bonds, or residual bonds, in a Collateralized Mortgage Obligation (CMO) structure, are those that give the owner the right to any remaining collateral in the trust after all other bond classes have been retired, plus any reinvestment income earned by the trust.

Question 18

An FI funds a $5 million residential mortgage in 2017 by allocating capital and by issuing demand deposits.The mortgage represents a loan-to-value of 70 percent.The demand deposits have a reserve requirement of 10 percent and a deposit insurance premium of 23 basis points.

What would have been the capital requirements if the FI had securitized the mortgage?
A)$0.
B)$400,000.
C)$200,000.
D)$500,000.

Accepted Answer

If the mortgage was immediately securitized and removed from the balance sheet,there would be no capital requirements necessary.

Question 19

Which of the following is an example of a negative duration asset that is valuable as a portfolio-hedging device for an FI manager when included with regular bonds whose price-yield curves show the normal inverse relationship?
A)PO strip
B)IO strip
C)Class B bonds
D)Class Z bonds

Accepted Answer

An IO (Interest Only) strip is a negative duration asset that can be valuable as a portfolio-hedging device for an FI manager when included with regular bonds whose price-yield curves show the normal inverse relationship. IO strips increase in value when interest rates rise, causing a decrease in the value of regular bonds. This makes them useful for hedging against interest rate risk in a bond portfolio. PO strips (A) are also negative duration assets, but they decrease in value when interest rates rise, making them unsuitable for hedging against interest rate risk. Class B bonds (C) and Class Z bonds (D) do not have a negative duration and are not useful for hedging against interest rate risk.

Question 20

This is an accrual class of a CMO that makes a payment to bondholders only when preceding CMO classes have been retired.
A)Class A bonds.
B)Class B bonds.
C)Class C bonds.
D)Class Z bonds.

Accepted Answer

Class Z bonds are typically the most subordinate class in a CMO structure and are designed to receive no principal or interest payments until all previous classes of CMOs have been retired. Therefore, this fits the description given in the question. Class A, B, and C bonds do not have this characteristic.

Quiz 26: Securitization

Why are the class C bonds of a CMO highly attractive to insurance companies and pension funds?

Which of the following best explains the term burn-out factor?

These bonds of a CMO have some prepayment protection and expected durations of five to seven years depending on the level of interest rates and are primarily purchased by pension funds and life insurance companies.

Why are the regular GNMA pass-through not very attractive to insurance companies and pension funds seeking long-term duration assets to match their long-term duration liabilities?

Which of the following is NOT true of an R class CMO issue?

What is defined as the sum of the products of the time when principal payments are received and the amount of principal received all divided by total principal outstanding?

One hundred identical mortgages are pooled together into a pass-through security.Each mortgage has a $150,000 principal,a fixed annual interest rate of 8 percent (paid monthly) ,and is fully amortized over a term of 30 years. What is the monthly payment on the mortgage pass-through?

In regard to a CMO,which of the following bonds have the shortest average life with a minimum of prepayment protection?

Why do garbage class bonds often have a negative duration?

Which of these CMO bond issues has characteristics of both a zero-coupon bond and a regular bond?

A claim to the present value of the interest payments made by the mortgage holders in a GNMA pool is

Mortgage-backed bonds (MBB) differ from pass-through and CMOs in which of the following ways?

Which of the following is true concerning an assumable mortgage?

Identify the residual class of a CMO that gives the owner the right to any remaining collateral in the trust after all other bond classes have been retired plus any reinvestment income earned by the trust.

Which of the following is an example of a negative duration asset that is valuable as a portfolio-hedging device for an FI manager when included with regular bonds whose price-yield curves show the normal inverse relationship?

This is an accrual class of a CMO that makes a payment to bondholders only when preceding CMO classes have been retired.