Question 1

Why are the regular NHA MBS pass-throughs not very attractive to insurance companies and pension funds seeking long-term duration assets to match their long-term duration liabilities?

Accepted Answer

The answer of Why are the regular NHA MBS pass-throughs...

Question 2

Which of the following best explains the term burn-out factor?

Accepted Answer

The burn-out factor refers to the percent of the total mortgage pool that has been prepaid prior to the month under consideration. This factor is used to calculate the expected remaining life of the mortgages in the pool and is important in determining the prepayment risk of mortgage-backed securities.

Question 3

Which of the following is NOT true of an R class CMO issue?

Accepted Answer

The answer of Which of the following is NOT true...

Question 4

Which of the following is true concerning an assumable mortgage?

Accepted Answer

An assumable mortgage is a type of mortgage in which the mortgage terms and the mortgage contract are transferred from the seller to the buyer of a house. This allows the buyer to assume responsibility for the mortgage and continue making payments according to the original terms of the mortgage.

Question 5

Which of these CMO issues has characteristics of both a zero-coupon bond and a regular bond?

Accepted Answer

Class Z bonds have characteristics of both a zero-coupon bond and a regular bond. Like zero-coupon bonds, they do not pay regular interest payments but are sold at a discount and mature at face value. However, like regular bonds, they can have coupon payments and are subject to fluctuating market prices.

Question 6

An FI operating in the United States funds a US$5 million residential mortgage in 2014 by allocating capital and by issuing demand deposits. The mortgage represents a loan-to-value of 70 percent. The demand deposits have a reserve requirement of 10 percent and a deposit insurance premium to FDIC of 23 basis points. What amount of demand deposits are needed to fund the mortgage?

Accepted Answer

To fund the mortgage of US$5 million with a loan-to-value of 70%, we need to allocate 30% of the amount, i.e., US$1.5 million. 
To issue demand deposits of US$1.5 million, we need to calculate the required reserves as follows:
Required reserves = Deposit amount * Reserve requirement
Required reserves = US$1.5 million * 10%
Required reserves = US$150,000

The FI needs to pay a deposit insurance premium of 23 basis points on the demand deposits. Therefore, the total cost of funding the mortgage through demand deposits is:
Total cost = Deposit amount + Deposit insurance premium
Total cost = US$1,500,000 + (0.23% * US$1,500,000)
Total cost = US$1,500,000 + US$3,450
Total cost = US$1,503,450

Thus, the amount of demand deposits needed to fund the mortgage is US$1,503,450, which is closest to option C, US$5,555,555.

Question 7

What is defined as the sum of the products of the time when principal payments are received and the amount of principal received all divided by total principal outstanding?

Accepted Answer

This is the formula for calculating the weighted-average life of a bond, which is the average time until all the bond's cash flows are received.

Question 8

In regard to a CMO, which of the following have the shortest average life with a minimum of prepayment protection?

Accepted Answer

The answer of In regard to a CMO, which of...

Question 9

This is an accrual class of a CMO that makes a payment to bondholders only when preceding CMO classes have been retired.

Accepted Answer

Class Z bonds are the last to receive payments from the collateral pool and are therefore known as accruing classes. They only make payments to bondholders once all preceding CMO classes have been retired.

Question 10

These bonds have some prepayment protection and expected durations of five to seven years depending on the level of interest rates and are primarily purchased by pension funds and life insurance companies.

Accepted Answer

The answer of These bonds have some prepayment protection and...

Question 11

An FI operating in the United States funds a US$5 million residential mortgage in 2014 by allocating capital and by issuing demand deposits. The mortgage represents a loan-to-value of 70 percent. The demand deposits have a reserve requirement of 10 percent and a deposit insurance premium to FDIC of 23 basis points. What would have been the capital requirements if the FI had securitized the mortgage?

Accepted Answer

Securitizing the mortgage would remove it from the FI's balance sheet, eliminating the need for capital requirements associated with holding the mortgage.

Question 12

One hundred identical mortgages are pooled together into a pass-through security. Each mortgage has a $150,000 principal, a fixed annual interest rate of 8 percent (paid monthly), and is fully amortized over a term of 30 years. For the first monthly payment, what portion is principal and what portion is interest?

Accepted Answer

To calculate the first monthly payment, we need to find the monthly interest rate and the total number of payments.

Monthly interest rate = (8% / 12) = 0.00667
Total number of payments = 30 years x 12 months/year = 360 months

Using the formula for a fully amortized loan, we can calculate the monthly payment as follows:

Monthly payment = P x (r(1+r)^n) / ((1+r)^n - 1)
where P = principal, r = monthly interest rate, and n = total number of payments

Plugging in the numbers, we get:

Monthly payment = $150,000 x (0.00667(1+0.00667)^360) / ((1+0.00667)^360 - 1) = $1,102.64

Now we need to determine the portion of the payment that goes towards principal and the portion that goes towards interest.

The interest portion of the payment is simply the monthly interest rate times the remaining balance on the loan. For the first payment, the remaining balance is equal to the original principal, since no payments have been made yet.

Interest portion = 0.00667 x $150,000 = $1,000.50

The principal portion is the difference between the monthly payment and the interest portion.

Principal portion = $1,102.64 - $1,000.50 = $102.14

Since there are 100 identical mortgages in the pool, the total interest portion of the first payment is:

Total interest = 100 x $1,000.50 = $100,050

And the total principal portion is:

Total principal = 100 x $102.14 = $10,214

Therefore, the answer is D: $100,000 interest and $10,065 principal.

Question 13

Which of the following is an example of a negative duration asset that is valuable as a portfolio-hedging device for an FI manager when included with regular bonds whose price-yield curves show the normal inverse relationship.

Accepted Answer

An IO strip (interest-only strip) is an example of a negative duration asset that can be valuable as a portfolio-hedging device for an FI manager. This is because the price-yield curve of an IO strip moves in the opposite direction of regular bonds, which can help offset potential losses in the bond portfolio. PO strips (principal-only strips) have positive duration and would not be useful for hedging in this scenario. Class A, B, and Z bonds do not necessarily have negative duration and are not specifically designed as hedging devices.

Question 14

Identify the residual class of a CMO that gives the owner the right to any remaining collateral in the trust after all other bond classes have been retired plus any reinvestment income earned by the trust.

Accepted Answer

Class R bonds, or residual bonds, in a Collateralized Mortgage Obligation (CMO) structure, are those that give the owner the right to any remaining collateral in the trust after all other bond classes have been retired, plus any reinvestment income earned by the trust.

Question 15

One hundred identical mortgages are pooled together into a pass-through security. Each mortgage has a $150,000 principal, a fixed annual interest rate of 8 percent (paid monthly), and is fully amortized over a term of 30 years. What is the monthly payment on the mortgage pass-through?

Accepted Answer

To calculate the monthly payment on each mortgage, we can use the formula:

M = P * (r/12) * (1 + r/12)^n / ((1 + r/12)^n - 1)

where M is the monthly payment, P is the principal ($150,000), r is the annual interest rate (8%), and n is the number of payments (30 years * 12 months/year = 360). Plugging in the numbers, we get:

M = 150,000 * (0.08/12) * (1 + 0.08/12)^360 / ((1 + 0.08/12)^360 - 1) = $1,100.65

So the monthly payment on each mortgage is $1,100.65. Since there are 100 mortgages in the pool, the total monthly payment on the pass-through security is:

$1,100.65 * 100 = $110,065

Therefore, the best choice is B, $110,065.

Question 16

One hundred identical mortgages are pooled together into a pass-through security. Each mortgage has a $150,000 principal, a fixed annual interest rate of 8 percent (paid monthly), and is fully amortized over a term of 30 years. If the entire mortgage pool is repaid after the second month, what is the second month's (liquidating) principal and interest payments?

Accepted Answer

The answer of One hundred identical mortgages are pooled together...

Question 17

An FI operating in the United States funds a US$5 million residential mortgage in 2014 by allocating capital and by issuing demand deposits. The mortgage represents a loan-to-value of 70 percent. The demand deposits have a reserve requirement of 10 percent and a deposit insurance premium to FDIC of 23 basis points. What is the deposit insurance premium on the demand deposits issued to fund the mortgage?

Accepted Answer

First, calculate the amount of demand deposits needed to fund the mortgage:

$5 million x 70% = $3.5 million

To account for the reserve requirement, the FI must hold:

$3.5 million / 0.9 = $3.89 million in demand deposits

To calculate the deposit insurance premium, we need to multiply the amount of demand deposits by the premium rate:

$3.89 million x 0.23% = $8,947

So the deposit insurance premium on the demand deposits issued to fund the mortgage is $8,947, which is closest to answer choice B, $12,778.

None of the other answer choices are close to this amount, so it must be the best choice.

Question 18

An FI operating in the United States funds a US$5 million residential mortgage in 2014 by allocating capital and by issuing demand deposits. The mortgage represents a loan-to-value of 70 percent. The demand deposits have a reserve requirement of 10 percent and a deposit insurance premium to FDIC of 23 basis points. What is the minimum capital requirement on the mortgage in order for the institution to be adequately capitalized?

Accepted Answer

The answer of An FI operating in the United States...

Question 19

Why are the class C bonds highly attractive to insurance companies and pension funds?

Accepted Answer

Class C bonds are highly attractive to insurance companies and pension funds due to their long expected duration, which aligns well with the long-term liabilities these institutions manage.

Question 20

Why do garbage class bonds often have a negative duration?

Accepted Answer

Garbage class bonds, often referred to as high-yield or junk bonds, have a negative duration because their value tends to increase when interest rates rise. This is contrary to the typical bond behavior where values decrease as interest rates increase. The reason behind this anomaly is that higher interest rates often signal a stronger economy, which can improve the financial health of the issuers of high-yield bonds, thus reducing their default risk and increasing the value of these bonds.

Quiz 26: Securitization Index