Question 1

Which one of the following is the reason that Macaulay duration is NOT a good measure of interest rate risk for mortgage bonds?

Accepted Answer

Macaulay duration assumes payments are fixed while mortgage bond payments vary due to changes in interest rates and principal payments. This makes it a poor measure of interest rate risk for mortgage bonds.

Question 2

Which one of the following is correct concerning the total payment amount on a PO strip?

Accepted Answer

The answer of Which one of the following is correct...

Question 3

A mortgage pool was created six years ago. Which one of the following PSA values is most apt to apply to that pool if market mortgage rates have been declining quite rapidly over the past five years?

Accepted Answer

The answer of A mortgage pool was created six years...

Question 4

You just purchased a GNMA mortgage-backed security. Which one of the following should you expect to receive?

Accepted Answer

GNMA (Government National Mortgage Association) mortgage-backed securities typically provide variable monthly payments. These payments vary because they include both interest and principal repayments, which can fluctuate based on the underlying mortgages' prepayment rates.

Question 5

Historically, what has been the relationship between bond prepayment rates and the market rate of interest?

Accepted Answer

Bond prepayment rates and the market rate of interest are inversely related. When interest rates decrease, homeowners are more likely to refinance their mortgages, which leads to higher prepayment rates on mortgage-backed securities. Conversely, when interest rates increase, prepayment rates tend to decrease as homeowners are less likely to refinance.

Question 6

The greater the prepayment rate for a mortgage pool, the:

Accepted Answer

The greater the prepayment rate for a mortgage pool, the faster the principal of the underlying mortgages is paid off, resulting in a greater decline in the bond principal for bonds supported by the pool. This is because the mortgage holder will prepay the principal amount sooner, reducing the amount of interest payments made, which reduces the cash flow available to support the bonds.

Question 7

Which one of the following statements correctly relates to GNMA securities?

Accepted Answer

GNMA securities are backed by pools of mortgages guaranteed by the FHA or VA. The main risk associated with GNMAs is prepayment risk, as borrowers have the option to pay off their mortgages earlier than expected. The minimal denomination of a GNMA when issued is $25,000, not $10,000. GNMAs were not originally established as an agency within the Department of Veteran's Affairs. Finally, while the mortgages in GNMA pools are guaranteed by the FHA or VA, the securities themselves are not guaranteed by any government agency.

Question 8

After 30 months, what is the 100 PSA benchmark conditional prepayment rate per year?

Accepted Answer

The 100 PSA benchmark conditional prepayment rate per year after 30 months is 6 percent. This means that 6 percent of the remaining principal of the mortgage-backed security is expected to be prepaid by the borrowers each year, assuming a steady prepayment rate.

Question 9

How much faster will a mortgage pool with a PSA of 150 be prepaid as compared to the benchmark?

Accepted Answer

The PSA (Public Securities Association) benchmark assumes a certain rate of prepayment speed. A PSA of 100 is considered the standard or benchmark prepayment speed. A PSA of 150 means that prepayments are expected to occur at 150% of the benchmark speed, or 1.5 times faster than the benchmark.

Question 10

How long is the expected average mortgage life of a mortgage held in a 30-year mortgage pool with a 100 PSA?

Accepted Answer

The answer of How long is the expected average mortgage...

Question 11

If the prepayment schedule for a mortgage pool increases to 100 PSA from 50 PSA, the related interest-only strips will _____ in value and the related principal-only strips will _____ in value.

Accepted Answer

The answer of If the prepayment schedule for a mortgage...

Question 12

Generally, the average life of a mortgage is _____ the mortgage's stated maturity.

Accepted Answer

The average life of a mortgage is typically much less than the mortgage's stated maturity because borrowers often make extra payments or refinance their mortgages, resulting in early repayment.

Question 13

Which of the following affect the value of a PO strip based on a GNMA bond?
I. changes in the PSA schedule
II. prepayment rates
III. time value of money
IV. changes in the default rates for the underlying mortgages

Accepted Answer

The value of a Principal Only (PO) strip from a GNMA bond is affected by changes in the PSA schedule (I), prepayment rates (II), and the time value of money (III). Changes in the default rates (IV) do not directly affect PO strips because GNMA guarantees timely payment of principal, thus mitigating the impact of defaults.

Question 14

Which one of the following is the preferred method of evaluating interest rate risk on mortgage bonds?

Accepted Answer

Effective duration is the preferred method of evaluating interest rate risk on mortgage bonds because it captures the price sensitivity of mortgage bonds to changes in interest rates by taking into account the optionality embedded in them such as prepayment risk. PSA rating, Macaulay duration, and postponed duration are other methods of evaluating interest rate risk, but they do not fully capture the impact of prepayment risk on the value of mortgage bonds. Modified duration is commonly used for evaluating interest rate risk on bonds, but it is not the preferred method for mortgage bonds because it assumes a parallel shift in the yield curve, which does not happen in the case of mortgage bonds.

Question 15

Monthly payments to investors in GNMA mortgage-backed bonds include which of the following cash flows?
I. mortgage interest
II. fixed principal payment
III. scheduled amortization of mortgage principal
IV. mortgage prepayments

Accepted Answer

GNMA mortgage-backed bonds pay investors monthly cash flows that include mortgage interest, scheduled amortization of mortgage principal, and mortgage prepayments. However, there is no fixed principal payment as the amount of principal paid each month varies depending on the prepayment activity of the underlying mortgage loans. Choice C includes all of these cash flows, making it the best choice.

Question 16

GNMA mortgage pools are based on mortgages issued by which of the following?
I. FHLMC
II. FNMA
III. FHA
IV. FmHA

Accepted Answer

III and IV onlyGNMA (Government National Mortgage Association) mortgage pools are based on mortgages insured or guaranteed by the Federal Housing Administration (FHA) and the Farmers Home Administration (FmHA), not those issued by the Federal Home Loan Mortgage Corporation (FHLMC) or the Federal National Mortgage Association (FNMA).

Question 17

Which one of the following is the key function of GNMA?

Accepted Answer

The key function of GNMA (also known as Ginnie Mae) is to sponsor the repackaging of mortgages into mortgage-backed securities pools. This allows for the pooling and selling of loans to investors, thus providing liquidity to the mortgage market and freeing up funds for lenders to make more loans. Options A, B, C and D are all incorrect as they do not accurately describe the key function of GNMA.

Question 18

Which one of the following is a government agency?

Accepted Answer

GNMA (Government National Mortgage Association) is a government agency also known as Ginnie Mae. FHLMC, Fannie Mae, Freddie Mac, and FNMA are all government-sponsored entities but not government agencies.

Question 19

You acquired a 30-year mortgage two years ago to purchase your current residence. Your mortgage is classified as which one of the following?

Accepted Answer

A mortgage is considered "seasoned" if it has a history of timely payments for at least one year. Since the mortgage in question is only two years old and the term "seasoned" typically applies after a longer period of consistent payments, it is more accurately described as "unseasoned."

Question 20

Which one of the following statements regarding an original issue $25,000 GNMA bond is correct?

Accepted Answer

GNMA bonds, also known as Ginnie Mae bonds, are backed by the full faith and credit of the U.S. government and represent ownership in a pool of mortgage loans. Investors receive monthly payments that include both interest and principal, meaning the total amount received over the life of the bond should exceed the original investment due to the interest earned. However, the exact amount of each payment can vary based on changes in the underlying mortgage payments, such as prepayments.

Quiz 20: Mortgage-Backed Securities