Question 1

The tranches in a collateralized mortgage obligation (CMo) that are most likely to provide protection for investors against both extension and contraction risk are:

Accepted Answer

PaC tranches are structured to provide protection to investors against both extension and contraction risk. They are designed to pay principal and interest according to a predetermined schedule, which helps to reduce the variability of cash flows and limit the potential impact of prepayments on investors. Support tranches are designed to absorb losses and provide credit enhancement, while sequential-pay tranches are structured to provide a specific priority of payment based on their order of priority. While both support and sequential-pay tranches may offer certain benefits to investors, they do not provide the same level of protection against extension and contraction risk as PaC tranches.

Question 2

Which of the following best describes the cash flow that owners of credit card receivable asset-backed securities receive during the lockout period?

Accepted Answer

During the lockout period, owners of credit card receivable asset-backed securities typically receive cash flows from finance charges and fees collected on the underlying credit card accounts, but not the principal payments.

Question 3

The Cdo tranche with a credit rating status between senior and subordinated bond class- es is called the:

Accepted Answer

The tranche with a credit rating status between senior and subordinated bond classes is called the mezzanine tranche. The equity tranche is the riskiest tranche with no credit rating and the residual tranche is the last tranche that absorbs any remaining losses after all other tranches have been paid in full.

Question 4

Support tranches are most appropriate for investors who are:

Accepted Answer

Support tranches are designed to absorb prepayment risk, offering potentially higher returns to investors willing to accept this risk.

Question 5

Which of the following is most likely an advantage of collateralized mortgage obligations (CMos)? CMos can

Accepted Answer

Collateralized mortgage obligations (CMOs) can meet the asset/liability requirements of institutional investors, making them a potentially attractive option for these investors. While CMOs may offer some protection against prepayment risk, it is not a guarantee, and they are not created directly from a pool of mortgage loans but rather from Mortgage-Backed Securities (MBS).

Question 6

a commercial mortgage-backed security (CMBS) does not meet the debt-to-service cov- erage at the loan level necessary to achieve a desired credit rating. Which of the following Features would most likely improve the credit rating of the CMBS?

Accepted Answer

Subordination refers to the structure of the CMBS where certain bondholders have priority over others in the repayment of principal and interest. This can provide a higher level of protection for senior bondholders, improving the credit rating of the CMBS. Call protection and balloon payments do not necessarily directly impact the debt-to-service coverage at the loan level.

Question 7

an excess spread account incorporated into a securitization is designed to limit:

Accepted Answer

An excess spread account is used to limit credit risk in a securitization. This account receives the difference between the interest received on the underlying assets and the interest paid to investors in the securities issued by the securitization. By having this buffer, the excess spread account can absorb losses from defaults on the underlying assets without impacting the payments to investors. This reduces the credit risk for investors in the securitization.

Question 8

Which of the following investments is least subject to prepayment risk?

Accepted Answer

Commercial mortgage-backed securities (CMBS) are least subject to prepayment risk as commercial mortgages are typically held to maturity and prepayments are less common compared to residential mortgages or auto loans. Auto loan receivable-backed securities and non-agency residential mortgage-backed securities (rMBS) are subject to higher prepayment risk as borrowers may choose to pay off their loans early.

Question 9

The key to a Cdo's viability is the creation of a structure with a competitive return for the:

Accepted Answer

The answer of The key to a Cdo's viability is...

Question 10

Which type of asset-backed security is not affected by prepayment risk?

Accepted Answer

Credit card receivable ABS are not affected by prepayment risk because the borrower cannot prepay the balance on their credit card. As long as the borrower makes minimum monthly payments, the underlying assets will continue to generate cash flows for the ABS investors. Auto loan and residential MBS are affected by prepayment risk because the borrowers can choose to pay off their loans early, which would result in a loss of future cash flows for the ABS investors.

Question 11

Credit risk is an important consideration for commercial mortgage-backed securities (CMBS) if the CMBS are backed by mortgage loans that:

Accepted Answer

Non-recourse loans do not provide the lender with any recourse to the borrower's assets other than the property being financed. Therefore, in the event of default, the lender's only option is to foreclose on the property. This increases the credit risk for the CMBS investors, as the value of the property may not be sufficient to cover the outstanding loan balance. Conversely, call protection and prepayment penalty points reduce the credit risk by providing additional cash flow to the CMBS investors and limiting the risk of early loan repayment.

Question 12

The single monthly mortality rate (SMM) most likely:

Accepted Answer

The single monthly mortality rate (SMM) measures the prepayment speed of a mortgage-backed security. It is expected that the SMM decreases as the contraction risk falls, meaning that borrowers are less likely to refinance their mortgage loans. When borrowers do not refinance, they do not prepay their mortgages, resulting in a decrease in SMM. The SMM may not stay fixed over time, as it depends on various factors affecting prepayment behavior, such as changes in interest rates and borrower characteristics. The SMM may increase as extension risk rises, but this is not the most likely scenario.

Question 13

If a default occurs in a non-recourse commercial mortgage-backed security (CMBS), the lender will most likely:

Accepted Answer

In a non-recourse CMBS, the lender can only look to the property securing the loan to recover losses in the event of a default. They cannot initiate a claim against the borrower for any shortfall, nor can they recover prepayment penalty points. Therefore, the lender will most likely rely solely on the proceeds received from the sale of the property to recover losses.

Question 14

In the context of mortgage-backed securities, a conditional prepayment rate (CPr) of 8% means that approximately 8% of the outstanding mortgage pool balance at the beginning Of the year is expected to be prepaid:

Accepted Answer

The CPr is an annualized measure of the expected prepayments on a mortgage-backed security. Therefore, if the CPr is 8%, it means that by the end of the year, approximately 8% of the outstanding mortgage pool balance is expected to be prepaid.

Question 15

In credit card receivable aBS, principal cash flows can be altered only when the:

Accepted Answer

In credit card receivable ABS, the principal cash flows can be altered only when the early amortization provision is triggered. This provision is in place to protect investors in case of a rapid deterioration of the underlying credit quality, triggering a payout event to investors. The excess spread account is used to support this provision and to ensure that the necessary funds are available in case of an early amortization, but it does not directly impact the principal cash flows. The lockout period is a certain period of time during which the principal is not repaid to investors, but again, it does not impact the ability to alter the principal cash flows. Therefore, choice C is the best answer.

Question 16

The longest-term tranche of a sequential-pay CMo is most likely to have the lowest:

Accepted Answer

The longest-term tranche in a sequential-pay CMO structure is most likely to have the lowest contraction risk because it is the last to receive principal payments, reducing the likelihood of early repayment.

Question 17

Which commercial mortgage-backed security (CMBS) characteristic causes a CMBS to trade more like a corporate bond than a residential mortgage-backed security (rMBS)?

Accepted Answer

Call protection is a characteristic that causes CMBS to trade more like a corporate bond than an RMBS because it limits the ability of the borrower to prepay the loan, making the cash flows more predictable, similar to corporate bonds.

Question 18

Compared with the weighted average coupon rate of its underlying pool of mortgages, the pass-through rate on a mortgage pass-through security is:

Accepted Answer

The pass-through rate on a mortgage pass-through security is typically lower than the weighted average coupon rate of its underlying pool of mortgages because the pass-through rate must account for any fees or servicing costs associated with the securitization process.

Question 19

For a mortgage pass-through security, which of the following risks most likely increases as interest rates decline?

Accepted Answer

Contraction risk increases as interest rates decline because borrowers are more likely to refinance their mortgages at lower rates, leading to earlier than expected repayments to investors.

Question 20

In auto loan aBS, the form of credit enhancement that most likely serves as the first line of loss protection is the:

Accepted Answer

Excess spread, which is the difference between the interest received from the loan assets and the interest paid to the ABS investors, often serves as the first line of loss protection in auto loan ABS. This is because it can absorb initial losses before any other credit enhancement mechanisms are tapped.

Quiz 4: Introduction to Asset-Backed Securities