Question 1

One cause of residential mortgage prepayment risk is the sale of the mortgaged property.

Accepted Answer

When a borrower sells their mortgaged property, they may choose to pay off the remaining mortgage balance, either voluntarily or as a requirement of the sale. This prepayment can result in a loss of expected interest income for the mortgage holder, creating prepayment risk.

Question 2

It is advantageous for the residential mortgage holder to refinance because market interest rates on new mortgages are less than interest rates on existing mortgages.

Accepted Answer

The answer of It is advantageous for the residential mortgage...

Question 3

Full amortization of a thirty-year fixed rate mortgage means that monthly payments are equal and include both principal and interest.

Accepted Answer

Full amortization of a thirty-year fixed rate mortgage means that the monthly payments are designed to pay off both principal and interest over the course of thirty years, resulting in equal monthly payments.

Question 4

A good news effect of increased mortgage prepayments on a mortgage pool caused by decreasing market interest rates includes the receipt of fewer scheduled interest payments.

Accepted Answer

Increased mortgage prepayments typically result in the early return of principal to investors, reducing the amount of time their investment earns interest, which is generally considered a negative effect since it leads to reinvestment risk, not a good news effect.

Question 5

Investors in GNMA pass-through securities are exposed to the risk that the originating bank may fail, and the risk that the trustee may mismanage monthly interest and principal payments collected.

Accepted Answer

GNMA pass-through securities are backed by the full faith and credit of the U.S. government, which mitigates the risk of the originating bank failing. Additionally, the role of the trustee in managing payments is structured to ensure the proper handling of interest and principal payments, reducing the risk of mismanagement.

Question 6

GNMA pass-throughs can assist an FI in resolving duration mismatch and illiquidity risk problems.

Accepted Answer

GNMA pass-throughs are mortgage-backed securities guaranteed by the Government National Mortgage Association (GNMA), also known as Ginnie Mae. They can help FIs manage duration mismatch and illiquidity risk by matching the maturity of the securities with the expected cash flows from the underlying mortgages. Additionally, GNMA pass-throughs are highly liquid, which can help FIs address issues of illiquidity.

Question 7

The weighted-average life of a loan is always greater than the duration of the loan.

Accepted Answer

The weighted-average life of a loan measures the average time until the principal is repaid, while duration measures the sensitivity of a loan's price to changes in interest rates and can be less than, equal to, or greater than the weighted-average life depending on the loan's characteristics and interest rate environment.

Question 8

Current statistics show that the servicing fee depository institutions can earn by securitizing through GNMA approximates 44 basis points.

Accepted Answer

The statement is correct, as per current statistics.

Question 9

GNMA pass-through bondholders can be protected against default risk by FHA/VA housing insurance.

Accepted Answer

GNMA pass-through bonds are comprised of mortgages backed by the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA). These mortgages are insured by the agencies, which provides a level of protection against default risk for bondholders.

Question 10

All tranches in a collateralized mortgage obligation (CMO) have the same prepayment risk exposure.

Accepted Answer

Each tranche in a CMO carries a different prepayment risk exposure, depending on its structure and priority of payment. For example, a Z-tranche has the least prepayment risk exposure, while an A-tranche has the highest.

Question 11

Mortgage pools that are assumed to prepay at a rate of speed that is more rapid than the PSA model would indicate, are said to prepay at less than 100 percent PSA behavior because the mortgage life and balance will exist for a longer time.

Accepted Answer

If the mortgage pool prepay rate is more rapid than the PSA model, it is said to prepay at greater than 100 percent PSA behavior, not less than 100 percent. This is because the mortgages will be paid off sooner than expected, resulting in a shorter remaining life and balance.

Question 12

Early prepayments on mortgages backing a CMO are normally allocated to the earliest existing tranche maturity.

Accepted Answer

Early prepayments on mortgages backing a CMO are normally allocated to the earliest existing tranche maturity according to the waterfall structure of the CMO. This ensures that investors in the earlier tranches receive their principal payments first, while investors in the later tranches bear more of the prepayment risk.

Question 13

All else equal, once a mortgage pool has aged, prior prepayments of mortgages in the pool have no bearing on the current value of the pool or the future prepayment rates of mortgages left in the pool.

Accepted Answer

Prior prepayments can affect the current value and future prepayment rates of the remaining mortgages in the pool because they can change the composition of the pool, potentially leaving behind mortgages that are less likely to prepay (due to selection bias). This can affect the average life and yield of the remaining pool.

Question 14

Prepayment models are attempts by professional mortgage portfolio managers to estimate the rate of prepayment on given mortgage pools.

Accepted Answer

Prepayment models are indeed used by professional mortgage portfolio managers to estimate the rate of prepayment on given mortgage pools.

Question 15

The call option held by the residential mortgage holder is in the money when market interest rates are less than the interest rate on an existing mortgage.

Accepted Answer

A call option gives the holder the right, but not the obligation, to buy a financial instrument at a specific price (strike price) on or before a specific date. In the case of a residential mortgage, the call option is held by the borrower and allows them to refinance their mortgage if market interest rates are lower than their existing interest rate. Therefore, if market interest rates are less than the interest rate on an existing mortgage, the call option is "in the money," meaning it has value and can be exercised to refinance the mortgage at a lower rate.

Question 16

Prepayment risk means that realized cash flows on pass-through securities may be more than expected cash flows.

Accepted Answer

Prepayment risk refers to the risk that borrowers will pay off their loans earlier than expected, leading to higher than anticipated cash flows for investors in pass-through securities, as they receive their principal back sooner.

Question 17

One advantage of asset securitization to a bank is the ability to originate new assets before the original assets have matured.

Accepted Answer

Asset securitization allows banks to sell off portions of their existing loans as securities to investors, generating cash flow for the bank. This frees up capital for the bank to originate new loans before the initial loans have matured.

Question 18

The ability to refinance a mortgage with no prepayment penalty gives the borrower a long-term put option on interest rates.

Accepted Answer

Refinancing with no prepayment penalty allows the borrower to take advantage of lower interest rates in the future, effectively giving them a put option on interest rates.

Question 19

A bad news effect of increased mortgage prepayments on a mortgage pool caused by decreasing market interest rates includes a reduction in the discount rate on the mortgage cash flow.

Accepted Answer

Increased mortgage prepayments due to decreasing market interest rates typically result in reinvestment risk for the holders of the mortgage pool, as they have to reinvest the prepaid principal at lower prevailing interest rates, not a reduction in the discount rate on the mortgage cash flow.

Question 20

CMOs are typically created from existing GNMA pass-through securities that are held in trust.

Accepted Answer

CMOs, or collateralized mortgage obligations, are typically created from existing GNMA (Government National Mortgage Association) pass-through securities that are held in trust. These securities are pooled and then repackaged into new securities with different maturity and payment structures.

Quiz 27: Securitization