Question 1

Which of the following affect the value of a PO strip based on a GNMA bond?
I.changes in the PSA schedule
II.prepayment rates
III.time value of money
IV.changes in the default rates for the underlying mortgages

Accepted Answer

The value of a Principal Only (PO) strip from a GNMA bond is affected by changes in the PSA schedule (I), prepayment rates (II), and the time value of money (III). Changes in the default rates (IV) do not directly affect PO strips because GNMA guarantees timely payment of principal, thus mitigating the impact of defaults.

Question 2

Which one of the following statements regarding an original issue $25,000 GNMA bond is correct?

Accepted Answer

GNMA bonds, also known as Ginnie Mae bonds, are backed by the full faith and credit of the U.S. government and represent ownership in a pool of mortgage loans. Investors receive monthly payments that include both interest and principal, meaning the total amount received over the life of the bond should exceed the original investment due to the interest earned. However, the exact amount of each payment can vary based on changes in the underlying mortgage payments, such as prepayments.

Question 3

Which one of the following statements correctly relates to GNMA securities?

Accepted Answer

GNMA securities are backed by government-guaranteed mortgage loans, and as such, are subject to prepayment risk. This means that if interest rates decline, homeowners are more likely to refinance their mortgages, which would result in investors receiving their principal back sooner than expected. Choosing any of the other options would be incorrect.

Question 4

Monthly payments to investors in GNMA mortgage-backed bonds include which of the following cash flows?
I.mortgage interest
II.fixed principal payment
III.scheduled amortization of mortgage principal
IV.mortgage prepayments

Accepted Answer

The answer of Monthly payments to investors in GNMA mortgage-backed...

Question 5

The greater the prepayment rate for a mortgage pool,the:

Accepted Answer

Prepayments reduce the principal of the mortgages in the pool, which in turn reduces the principal of the bonds supported by the pool. Therefore, a greater prepayment rate leads to a greater decline in the bond principal.

Question 6

Generally,the average life of a mortgage is _____ the mortgage's stated maturity.

Accepted Answer

The average life of a mortgage is usually much less than the mortgage's stated maturity. This is because most borrowers either refinance or sell their properties before the end of the mortgage term. As a result, the weighted average time that the mortgage principal is outstanding is usually shorter than the term of the mortgage.

Question 7

Which one of the following is correct concerning the total payment amount on a PO strip?

Accepted Answer

The answer of Which one of the following is correct...

Question 8

You just purchased a GNMA mortgage-backed security.Which one of the following should you expect to receive?

Accepted Answer

GNMA (Government National Mortgage Association) mortgage-backed securities typically provide variable monthly payments. These payments vary because they include both interest and principal repayments, which can fluctuate based on the underlying mortgages' prepayment rates.

Question 9

After 30 months,what is the 100 PSA benchmark conditional prepayment rate per year?

Accepted Answer

The 100 PSA benchmark represents a prepayment speed of 1% per month. After 30 months, this would equal a prepayment rate of 30%. The conditional prepayment rate is expressed as an annualized rate, so the answer would be 30% divided by 30 months (or 2.5 years) = 12% per year. However, the question is asking for the CPR at 100 PSA, so we need to adjust our answer. At 100 PSA, the prepayment speed is assumed to increase by 0.2% per month, so the new monthly speed would be 1% + 0.2% = 1.2%. After 30 months, this would equal a prepayment rate of 36%. Annualizing this rate would give us 36%/2.5 years = 14.4% per year. However, the answer choices are not in this range, so we need to round to the closest option, which is C) 6 percent.

Question 10

Which one of the following is the reason that Macaulay duration is NOT a good measure of interest rate risk for mortgage bonds?

Accepted Answer

Macaulay duration is not an appropriate measure of interest rate risk for mortgage bonds because mortgage payments vary based on changes in interest rates, while Macaulay duration assumes fixed payments.

Question 11

How much faster will a mortgage pool with a PSA of 150 be prepaid as compared to the benchmark?

Accepted Answer

A PSA of 150 means that the mortgage pool is expected to prepay at 1.5 times the rate of the benchmark. Therefore, it will be 1.5 times faster than the benchmark.

Question 12

Which one of the following is a government agency?

Accepted Answer

GNMA (Government National Mortgage Association) is a government agency within the U.S. Department of Housing and Urban Development (HUD). FHLMC (Federal Home Loan Mortgage Corporation), Fannie Mae (Federal National Mortgage Association), Freddie Mac (Federal Home Loan Mortgage Corporation), and FNMA (Federal National Mortgage Association) are all government-sponsored enterprises (GSEs) but not government agencies.

Question 13

GNMA mortgage pools are based on mortgages issued by which of the following?
I.FHLMC
II.FNMA
III.FHA
IV.FmHA

Accepted Answer

III and IV onlyGNMA (Government National Mortgage Association) mortgage pools are based on mortgages insured or guaranteed by the Federal Housing Administration (FHA) and the Farmers Home Administration (FmHA), not those issued by the Federal Home Loan Mortgage Corporation (FHLMC) or the Federal National Mortgage Association (FNMA).

Question 14

Which one of the following is the key function of GNMA?

Accepted Answer

GNMA, or Government National Mortgage Association, sponsors the repackaging of mortgages into mortgage-backed securities pools. This means that they create pools of mortgages that are then sold to investors as securities. GNMA guarantees the timely payment of principal and interest on these securities, which makes them attractive to investors. GNMA does not directly finance home buyers or provide funds to specific groups such as military personnel or farmers.

Question 15

You acquired a 30-year mortgage two years ago to purchase your current residence.Your mortgage is classified as which one of the following?

Accepted Answer

A mortgage is considered "seasoned" if it has a history of timely payments for at least one year. Since the mortgage in question is only two years old and the term "seasoned" typically applies after a longer period of consistent payments, it is more accurately described as "unseasoned."

Question 16

A mortgage pool was created six years ago.Which one of the following PSA values is most apt to apply to that pool if market mortgage rates have been declining quite rapidly over the past five years?

Accepted Answer

The answer of A mortgage pool was created six years...

Question 17

How long is the expected average mortgage life of a mortgage held in a 30-year mortgage pool with a 100 PSA?

Accepted Answer

The answer of How long is the expected average mortgage...

Question 18

Which one of the following is the preferred method of evaluating interest rate risk on mortgage bonds?

Accepted Answer

Effective duration is the preferred method of evaluating interest rate risk on mortgage bonds as it accounts for changes in both interest rates and prepayment behavior. PSA rating is a prepayment model used to forecast prepayment speeds, while modified duration and Macaulay duration only account for changes in interest rates. Postponed duration is not a commonly used method for evaluating interest rate risk.

Question 19

Historically,what has been the relationship between bond prepayment rates and the market rate of interest?

Accepted Answer

Bond prepayment rates and the market rate of interest have an inverse relationship. As interest rates increase, borrowers are less likely to refinance their mortgages, leading to lower prepayment rates for mortgage-backed securities. Conversely, as interest rates decrease, borrowers are more likely to refinance their mortgages, leading to higher prepayment rates.

Question 20

If the prepayment schedule for a mortgage pool increases to 100 PSA from 50 PSA,the related interest-only strips will _____ in value and the related principal-only strips will _____ in value.

Accepted Answer

When the prepayment schedule increases, the interest-only strips will decrease in value because prepayments reduce the amount of future interest payments that the holder of the interest-only strip will receive. On the other hand, the principal-only strips will increase in value because the prepayments will cause principal to be returned to the holder sooner, resulting in earlier cash flows which will increase their present value.

Quiz 20: Mortgage-Backed Securities

Which of the following affect the value of a PO strip based on a GNMA bond? I.changes in the PSA schedule II.prepayment rates III.time value of money IV.changes in the default rates for the underlying mortgages