Deck 20: The Secondary Mortgage Market: Cmos and Derivative Securities

Question 1

CDOs often include "B" notes, mezzanine debt and preferred equity as investments.

Answer 1

True

Question 2

What is the primary distinction between mortgage-related securities backed by residential mortgages and those backed by commercial mortgages?

A) Default is the key risk with residential mortgages; prepayment is the key risk with commercial mortgages
B) Interest rate risk is the key risk with residential mortgages; prepayment is the key risk with commercial mortgages
C) Prepayment is the key risk with residential mortgages; default is the key risk with commercial mortgages
D) Prepayment is the key risk with residential mortgages; interest rate risk is the key risk with commercial mortgages
E) There are no significant distinctions

Answer 2

Prepayment is the key risk with residential mortgages; default is the key risk with commercial mortgages

Question 3

In CDOs both equity and debt holder prefer riskier, higher-yielding collateral to collect excess spreads.

Answer 3

False

Question 4

Which of the following statements regarding subprime mortgages is TRUE?

A) Subprime mortgages are not Ginnie Mae guaranteed, so CMO investors are exposed to default risk
B) Subprime mortgages are not Ginnie Mae guaranteed, so securities backed by subprime mortgages cannot be issued
C) CMOs backed by subprime mortgages cannot be used as collateral for CDOs
D) Because of diversification, securities backed by subprime loans and no more risky than those back by prime loans

Question 5

The CMO is a considered a marketing innovation as well as a financial innovation, because the different it is the first security in the secondary mortgage market to have run a prime-time television ad.

Question 6

CMO investors only pay taxes on interest income.

Question 7

A CMO does not completely eliminate prepayment risk.

Question 8

CDO managers raises capital through the issuance of rated CDO debt and equity to purchase an undiversified pool of credit instruments.

Question 9

If a premium is paid on a CMO issue at the time of issue), yields will increase as prepayment rates accelerate.

Question 10

In CMO terminology, planned amortization classes PACs) are also known as companion tranches.

Question 11

Investors retain prepayment risk on MBBs, but issuers incur this risk with MPTs.

Question 12

The issuer of a mortgage pass-through bond bears all of the prepayment risk of the underlying mortgages.

Question 13

Cash flows remaining after all CMO tranches have been paid off are referred to as REMICs.

Question 14

One way in which a mortgage pay-through bond MPTB) is similar to a mortgage-backed bond MBB) is that the pay-through bond is a debt obligation of the issuer.

Question 15

A floater is a CMO tranche that has a variable interest rate.

Question 16

The CMO investor assumes the prepayment risk of the underlying mortgages, although the CMO modifies how the risk is allocated.

Question 17

From the issuer's perspective, the use of MBBs and MPTBs should be viewed as a method of debt financing.

Question 18

$$\begin{array} { c c r } \text { Tranche } & \text { Principal } & \text { Caupan Rate } \\\text { A } & \$ 40,000,000 & \mathbf { 9 . 2 5 \% } \\\mathrm { B } & 30,000,000 & 10.00 \% \\Z & 30,000,000 & 11.00 \%\end{array}$$

-A mortgage company is issuing a CMO with three tranches, with the principal and coupon rate given in the table above. What will be the weighted average coupon on the CMO when issued?

A) 9.25%
B) 10.00%
C) 10.08%
D) 11.00%

Question 19

In comparison to mortgage pass-though securities, CMOs attract a broader class of investors because, by prioritizing cash flows, they can offer more specific maturities.

Question 20

A derivative security derives its value from another security, index, or financial claim.

Question 21

The credit rating of an MPTB depends largely on the:

A) Amount of overcollateralization
B) Degree to which government-related securities constitute the excess collateral
C) Riskiness of the mortgage in the underlying pools
D) All of the above

Question 22

For which of the following investments does the issuer bear prepayment risk?

A) CMOs
B) MBBs
C) MPTs
D) MPTBs

Question 23

Duration, as referred to in this chapter, is defined as:

A) A measure of the extent to which different investments expose an investor to interest rate risk
B) A measure of the weighted-average time required before all principal and interest is received on an investment
C) A measure that takes into account both the size of cash flows and the timing of their receipt
D) All of the above

Question 24

The residual position in the CMO offering is considered which kind of position?

A) Primary
B) Equity
C) Interest
D) Debt

Question 25

The main purpose of the Term Asset-Backed Securities Loan Facility TALF) is to:

A) Buy mortgage backed securities owned by Freddie Mac, Fannie Mae, and Ginnie Mae
B) Issue CDOs and use the proceeds to fund infrastructure projects to stimulate the economy
C) Regulate hedge funds to reduce investments in risky assets
D) Use residential loans as collateral to purchase U.S. Treasuries as a way to reduce interest rates

Question 26

For which of the following investments is the date of maturity known?

A) CMOs
B) MBBs
C) MPTs
D) MPTBs

Question 27

The total interest collected from the pool is ______ if prepayment accelerates; therefore, the dollar spread between interest inflow and outflow becomes ______.

A) Lower, smaller
B) Lower, wider
C) Higher, smaller
D) Higher, wider

Question 28

Which of the following is NOT a CMO security type?

A) A repeat floater
B) A Z tranche
C) An inverse floater
D) An IO tranche

Question 29

Which of the following does NOT increase the noncredit risks of CDOs?

A) Collateral management risk
B) Certainty in average life of CDO tranches
C) Higher correlation and liquidity
D) None of the above

Question 30

A calamity call, which allows the issuer to recall all securities for a specified time, can be used in each of the following situations EXCEPT when:

A) Investors want to cash out their positions
B) Interest rates decline sharply
C) Prepayments decline sharply
D) Reinvestment rates are below what was promised to investors

Question 31

Which of the following statements regarding mortgage pass-through bonds MPTBs) is FALSE?

A) MPTBs can be viewed as mortgage-backed bonds with the pass-through of principal and prepayment features of a mortgage pass-through security
B) Most MPTBs are based on residential mortgage pools and are generally overcollateralized
C) MPTBs represent an undivided equity ownership interest in a mortgage pool
D) All of the above are false.

Question 32

Convexity is a gage for which of the following?

A) Profitability
B) Return
C) Sensitivity
D) Duration

Question 33

Which of the following investments in NOT a debt obligation of the issuer?

A) CMOs
B) MBBs
C) MPTs
D) MPTBs

Question 34

Which of the following is NOT characteristic of commercial-backed mortgage securities?

A) The underlying mortgage pool represents a variety of different property types retail, multifamily, etc.) and a specific geographical area
B) The underlying mortgages have usually been outstanding for several years
C) One of the primary issuers of such securities are insurance companies
D) In general, the underlying mortgage pool for such securities contain fewer mortgages than are included in residential-backed mortgage pools

Question 35

Which of the following is FALSE regarding a planned amortization class PAC) tranche?

A) It has the greatest degree of cash flow certainty
B) Variable payments are received
C) Payments are received over predetermined period of time
D) Payments are received under a range of prepayment scenarios

Question 36

REMICs were created in order to avoid taxes:

A) Entirely
B) At the investor level
C) At the entity level
D) No taxes can be avoided.

Question 37

In comparison to the mortgage securities we have previously discussed, the unique characteristic of CMOs is that:

A) CMO issuers retain ownership of the underlying mortgage pool
B) CMOs are issued in multiple security classes
C) The CMO mortgage pool is not overcollateralized
D) CMOs are a pay-through in which all amortization and prepayments flow through to investors