Question 1

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

The statement is incorrect. Mortgage pools that prepay at a rate faster than the PSA model would indicate are said to prepay at greater than 100 percent PSA behavior, not less. This is because the mortgage life and balance will exist for a shorter time.

Question 2

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 3

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 mortgage portfolio managers to estimate the rate at which borrowers will prepay their mortgages. This information is important in managing the risk associated with investing in mortgage-backed securities.

Question 4

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

Accepted Answer

GNMA pass-through bonds are made up of pools of mortgage loans insured by FHA/VA housing insurance. This insurance protects bondholders against default risk.

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

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

Accepted Answer

Tranches in a CMO have different prepayment risk exposures, depending on their priority in receiving cash flows from the underlying mortgage pool. Some tranches may be more exposed to prepayment risk than others.

Question 7

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 8

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 9

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

Accepted Answer

Current statistics indicate that the servicing fee depository institutions can earn by securitizing through GNMA is approximately 44 basis points.

Question 10

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 11

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

Accepted Answer

With a fully amortized thirty-year fixed rate mortgage, the monthly payments are designed to pay off both the principal and interest over the loan term of thirty years.

Question 12

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

When market interest rates are less than the interest rate on an existing mortgage, the borrower has an incentive to refinance the mortgage at a lower rate. This means the call option held by the residential mortgage holder is in the money, as they can exercise it and receive the underlying asset (the mortgage) at a higher rate than the current market.

Question 13

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

Accepted Answer

GNMA pass-throughs can help mitigate duration risk as the underlying mortgages have fixed interest rates and regular principal payments, which can offset changes in interest rates. Additionally, GNMA pass-throughs can be traded on the secondary market, providing liquidity to FIs.

Question 14

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

Accepted Answer

CMOs (Collateralized Mortgage Obligations) are created by securitizing mortgage loans, which are then grouped into pools and then divided into separate bond classes known as tranches. These tranches are then sold as investment securities to investors. Initially, the existing GNMA pass-through securities are used to create the CMOs.

Question 15

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 a bank to sell off its existing assets to investors and use the proceeds to originate new assets. Therefore, it enables the bank to generate new loans and investments without waiting for the existing ones to mature.

Question 16

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

Accepted Answer

When a homeowner sells their property, they typically pay off their mortgage in full, which can result in prepayment penalties for the lender and a loss of potential future interest income. This is one of the causes of residential mortgage prepayment risk.

Question 17

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 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 a mortgage with no prepayment penalty allows the borrower to take advantage of lower interest rates by paying off the existing loan and taking out a new one. This is similar to a put option in finance, as it gives the borrower the ability to sell their existing mortgage and lock in a lower rate.

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

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

Accepted Answer

This is known as the "waterfall" structure of CMOs, where prepayments are first allocated to the earliest tranche maturity before being applied to later tranches. This ensures that investors in the earlier tranches are repaid first before the later tranches receive any payments.

Quiz 26: Securitization