Question 1

26-26 Full amortization of a thirty-year mortgage means that monthly payments are equal and include both principal and interest.

Accepted Answer

Full amortization means that the payments are designed to fully pay off the mortgage over the course of the specified term, in this case thirty years, through equal monthly payments that include both principal and interest.

Question 2

26-39 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, which means that the investors in that tranche will receive their principal back sooner than expected. This is known as "prepayment risk" and is a key feature of CMOs.

Question 3

26-32 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 26-32 It is advantageous for the residential...

Question 4

26-40 CMOs are typically created from existing GNMA pass-through securities that are held in trust.

Accepted Answer

CMOs are created by dividing existing GNMA pass-through securities into multiple classes or tranches based on different risk exposures, prepayment characteristics, and yield levels. These tranches are then sold to investors as CMOs, which are backed by the underlying mortgage loans.

Question 5

26-25 Current statistics show,that the servicing fee depository institutions can earn by securitizing through GNMA approximates 44 basis points.

Accepted Answer

The statement is true. Current statistics suggest that depository institutions can earn a servicing fee of approximately 44 basis points through securitizing with GNMA.

Question 6

26-38 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

Mortgage pools that prepay at a more rapid rate than the PSA model indicates are said to prepay at greater than 100 percent PSA behavior because the mortgage life and balance will exist for a shorter time.

Question 7

26-41 The creation and sale of CMOs is based,at least in part,on the ability to segment the market for pass-through security products.

Accepted Answer

CMOs are mortgage-backed securities that are structured by pooling together individual mortgages and then segmenting them into tranches. These tranches are then sold to investors with varying levels of risk and return. The ability to segment the market for pass-through securities into different risk and return profiles is what enables the creation and sale of CMOs.

Question 8

26-24 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 guarantees timely payment of principal and interest, mitigating the risk of bank failure or trustee mismanagement.

Question 9

26-28 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 in the future, similar to having a put option on interest rates. Therefore, the statement is true.

Question 10

26-33 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

The call option held by the residential mortgage holder gives them the right to prepay their mortgage at any time, and it is in the money when market interest rates are lower than the interest rate on their existing mortgage. This allows them to refinance at a lower rate and save money on interest payments.

Question 11

26-35 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

The good news effect of increased mortgage prepayments due to decreasing market interest rates is that the mortgage pool can be reinvested at lower rates, but it does result in the receipt of fewer scheduled interest payments, which is typically considered a negative effect.

Question 12

26-34 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

A bad news effect of increased mortgage prepayments is typically a reduction in the expected cash flows from the mortgage pool, not a reduction in the discount rate. The discount rate is determined by market conditions and risk assessments, not directly by prepayment rates.

Question 13

26-27 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 the borrower will pay off their mortgage earlier than expected, leading to higher than anticipated cash flows for the holder of pass-through securities.

Question 14

26-30 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

Prepayments affect the remaining balance and the characteristics of the mortgage pool, influencing both its current value and future prepayment rates.

Question 15

26-42 Mortgage-backed bonds are a form of on-balance-sheet securitization.

Accepted Answer

Mortgage-backed bonds involve pooling together mortgages and issuing bonds that are backed by the cash flows from the underlying mortgages. These bonds are a type of on-balance-sheet securitization as they remain on the balance sheet of the issuer.

Question 16

26-37 The weighted-average life of a loan is greater than the duration of the loan.

Accepted Answer

The weighted-average life of a loan is typically less than or equal to the duration of the loan, as duration accounts for the time value of money and the timing of cash flows.

Question 17

26-36 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 predict the rate of prepayment on given mortgage pools.

Question 18

26-31 One cause of residential mortgage prepayment risk is the sale of the mortgaged property.

Accepted Answer

If a borrower sells their mortgaged property, they will have to pay off the remaining balance of their mortgage, which will result in prepayment of the mortgage. This is one of the causes of residential mortgage prepayment risk.

Question 19

26-23 GNMA pass-through bondholders can be protected against default risk by FHA/VA housing insurance.

Accepted Answer

GNMA pass-through bonds are backed by a pool of mortgages, including those insured by the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA). This insurance protects the bondholders against default risk, as the government agency will step in to cover any losses in the event of mortgage defaults. Therefore, option A is correct.

Question 20

26-29 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 convert illiquid assets into securities that can be sold to investors. This provides the bank with cash to originate new loans before the original loans have matured, thus allowing for increased lending capacity.

Quiz 26: Securitization