Deck 11: Valuation of Mortgage Securities

Question 1

The cash flows of mortgage-backed bonds:

A) are designed to appear as traditional callable debt
B) promise periodic coupon payments
C) promise the return of the face value at maturity
D) b and c
E) a and c

Answer 1

b and c

Question 2

One of the non-economic factors affecting the prepayment behavior of a mortgage pool is:

A) current market rates
B) pool rates
C) job relocation
D) all of the above are non-economic factors affecting prepayment behavior as outlined in this text

Answer 2

job relocation

Question 3

Variables that affect the sinking fund balance include:

A) the prepayment rate on mortgages in the pool
B) the reinvestment rate on the sinking fund
C) the initial overcollateralization
D) the default rate
E) all of the above

Answer 3

all of the above

Question 4

11-18.If the value of the IO strip is most sensitive to changes in the market rate when this rate is between 100 and 300 basis points below the coupon on the pool,then those investors who desire to obtain the hedging benefits of the IO strip should purchase:

A) strips of passthroughs 100-300 points below the market rate
B) only strips of passthroughs at the market rate
C) strips of passthroughs 100-300 points above the market rate
D) only PO strips 100-300 points below the market rate

Question 5

11-20.In any one period (month)the cash flows from a pool of several hundred mortgages will consist of:

A) scheduled amortization of principle
B) interest on the remaining principle
C) prepayments of a portion of the pool
D) a and b only
E) a,b,and c

Question 6

11-11.For traditional debt securities which of the following is false?

A) cash flows are fixed in terms of amount and payment date
B) for treasury bonds or (non-callable)corporate debt,an increase in the market rate of interest will lower their value
C) the longer the duration (similar to maturity)of the obligation,the less the changes in value as a result of a change in market rates
D) mortgage securities are very dissimilar to traditional types of debt

Question 7

Which is true?

A) the value of a pass-through is the sum of the component IO and PO
B) if interest rates rise above the coupon rate prepayment will accelerate
C) the acceleration of prepayment will reduce the value of the PO
D) the increase in market rates reduces the discount rate used to value the PO cash flows

Question 8

11-15.Which of the following is true?

A) even a slight increase in the default rate of a sinking fund has a dramatic impact on its balance
B) a large increase in the initial amount of over-collateralization has a minimal impact on the terminal fund balance
C) an increase in the yield on a sinking fund has a negative effect on the fund balance
D) the fund balance will rise with decreases in the PSA prepayment rate

Question 9

For a pool of mortgages (with no defaults),which of the following is false?

A) the total amount of principal (both scheduled and prepayments)that will be paid from the pool will depend upon changes in the interest rates
B) changes in the interest rate may cause the principal payments to be delayed or accelerated
C) the interest payments in any one month will depend upon the amount of principal outstanding at the beginning of the month
D) changes in the market rate of interest will affect the timing of prepayments

Question 10

11-12.For premium passthrough securities,which of the following is false?

A) investors require a higher yield to compensate for the fact that they are purchasing a callable debt
B) the value of the high coupon is somewhat offset by a lower expected prepayment rate
C) the price curves become flat above the percentage equal to the current market rate
D) price compression reflects the market perception of prepayment behavior for high coupon passthroughs

Question 11

The revenues associated with servicing loans include all except:

A) the servicing fee
B) the float on escrow accounts
C) the float between the receipt of monthly payments and the payment of proceeds to the purchaser of the loans
D) the administrative and overhead costs associated with servicing the pool

Question 12

11-16.Which of the following is false?

A) for a discounted security,an acceleration in prepayments increases the yield
B) for a discounted security,a delay in prepayments reduces the yield
C) for a premium security,an acceleration in prepayments increases the yield
D) for a premium security,a delay in prepayments increases the yield e all are true except c

Question 13

11-19.The CPR of passthroughs refers to:

A) coupon premium risk
B) coupon percentage rate
C) constant prepayment rate
D) cardio-pulmonary resuscitation

Question 14

The value of a PO will fall as a net effect if:

A) the market interest rate is up and the prepayment rate is down
B) the market interest rate is down and the prepayment rate is down
C) the market interest rate is up and the prepayment rate is unchanged
D) the market interest rate is up and the prepayment rate is up

Question 15

11-17.The current industry standard for the model of expected prepayments is:

A) the twelve-year prepaid life model
B) the constant prepayment rate model
C) the public securities association model
D) the econometric prepayment model

Question 16

11-14.Servicing a pool of loans may NOT include:

A) collecting monthly payments
B) maintaining an escrow account for property taxes and hazard insurance
C) Sending notices of default to the government
D) making claims to the mortgage insurance for losses on defaulted loans

Question 17

A graph of the PSA model for the prepayment rate on a pool of mortgages will produce a spike in the _________ year of cash flows:

A) second
B) third
C) fourth d fifth
E sixth

Question 18

Deep Check
For mortgage securities:

A) a change in the market rate of interest affects the rate used to discount the cash flows
B)a change in the market rate of interest affects the time patterns of the cash flows
C)the amount and timing of the cash flows are contingent upon the interest rates
D)a. and b. only
E)a, b, and c

Question 19

11-10.If prepayments of a mortgage pool accelerate:

A) it is advantageous to the PO investor
B) it is disadvantageous to the PO investor
C) it is advantageous to the IO investor
D) it is disadvantageous to both the PO and the IO investors

Question 20

11-13.The duration of passthroughs can be measured by:

A) calculating the amount of future cash flows
B) calculating the timing of future cash flows
C) both a and b
D) they are impossible to calculate because of uncertain prepayments

Question 21

11-22.An increase in the market rate of interest will:

A) slow the prepayment rate on discounted passthroughs
B) slow the prepayment rate on premium passthroughs
C) both a and b
D) will not affect either a or b because of the price compression theory

Question 22

11-24.Payments of principal from a pool of mortgages in excess of scheduled amortization is referred to as:

A) prepayment
B) yield-to-maturity payments
C) valuation
D) negative duration

Question 23

11-23.A security for which the cash flows derived from mortgages are rearranged in terms of amount and timing is referred to as:

A) mortgage-derivative security
B) valuation
C) interest-contingent security
D) interest rate duration

Question 24

11-21.A security for which the cash flows derived from mortgages are rearranged in terms of amount and timing is a:

A) mortgage-related security
B) collateralized mortgage obligation
C) mortgage-derivative security
D) pass-through security
E) all of the above

Question 25

11-25.If the value of an Interest-Only strip moves in the same direction as market interest rates,this means that an Interest-Only strip has:

A) negative duration
B) serving rights
C) value
D) inverse convexity