Question 1

26-78 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?
A)Weighted-average life.
B)Burn-out factor.
C)Degree of collateralization.
D)Option-adjusted spread.
E)Time to maturity.

Accepted Answer

This is the definition of weighted-average life, which is a measure of the expected time it will take for the principal of a bond to be repaid, taking into account the timing and amount of principal payments.

Question 2

26-67 Which of the following are functions of GNMA?
A)Engaging in swap transactions where it swaps mortgage-backed securities with an FI for original mortgages.
B)Sponsors mortgage-backed securities programs by FIs such as banks,thrifts,and mortgage bankers.
C)Acts as a guarantor to investors in mortgage-backed securities regarding the timely pass-through of principal and interest payments on their sponsored bonds.
D)All of the above.
E)Answers B and C only.

Accepted Answer

GNMA (Ginnie Mae) sponsors mortgage-backed securities programs and acts as a guarantor for timely payments, but it does not engage in swap transactions.

Question 3

26-68 Which is the oldest mortgage-backed security sponsoring agency?
A)GNMA.
B)FNMA.
C)FHA.
D)FMHA.
E)FHLMC.

Accepted Answer

FNMA (Federal National Mortgage Association), also known as Fannie Mae, was established in 1938, making it the oldest mortgage-backed security sponsoring agency among the options listed.

Question 4

26-74 Which of the following is NOT a factor that may cause the prepayment risk on a pool of mortgages to differ from the PSA's assumed pattern?
A)The age of the mortgage pool.
B)Geographic location.
C)Seasons in the year in which the mortgage was originated.
D)Full or partial amortization of the payments.
E)Assumability of mortgages in the pool.

Accepted Answer

The PSA assumes a constant prepayment rate throughout the year, regardless of the season in which the mortgages were originated. Therefore, the seasons in which the mortgages were originated do not affect the prepayment risk. The other factors listed, such as the age of the mortgage pool, geographic location, full or partial amortization, and assumability of mortgages, can all have an impact on prepayment risk.

Question 5

26-75 Mortgage-backed bonds (MBB)differ from pass-throughs and CMOs in which of the following ways?
A)The MBB bondholders have a junior claim to assets of the FI.
B)There is no direct link between the cash flow on the mortgages backing the bond and the interest and principal payments on the MBB.
C)The assets backing a MBB issue are normally removed from the balance sheet of the FI.
D)Tranches of a MBB are treated equally with respect to prepayments on mortgages backing the bond issue.
E)None of the above.

Accepted Answer

Unlike pass-throughs and CMOs, there is no direct link between the cash flows on the mortgages backing the MBB and the interest and principal payments on the MBB. Other differences listed in the options are not correct. MBB bondholders typically have a senior claim on the assets of the FI, and the assets backing the MBB issue are not normally removed from the balance sheet of the FI. Finally, tranches of a MBB may be structured differently to allocate prepayment risk differently.

Question 6

26-80 Which of the following is true concerning an assumable mortgage?
A)The aggregate percent of the mortgage pool that has been prepaid prior to the month under consideration.
B)The mortgage contract is transferred from the seller to the buyer of a house.
C)The required interest spread of a pass-through security over a treasury when prepayment risk is taken into account.
D)A mortgage-backed bond issued in multiple classes or tranches.
E)Bonds collateralized by a pool of assets.

Accepted Answer

An assumable mortgage is a type of mortgage in which the mortgage contract is transferred from the seller to the buyer of a house. This means that the buyer can "assume" the mortgage and take over the payments from the seller, without having to obtain a new mortgage.

Question 7

26-72 Investors in mortgage-backed pass-through securities are exposed to a variety of risks.Compared to other fixed-income securities,the most unique of these risks is
A)prepayment risk
B)default risk
C)credit risk
D)interest rate risk
E)liquidity risk

Accepted Answer

Prepayment risk is the most unique risk associated with mortgage-backed pass-through securities. This is because borrowers have the option to pay off their mortgages early, which can reduce the expected cash flows to investors. This risk is not present in other fixed-income securities such as bonds.

Question 8

26-66 Which of the following factors occurred in the early 2000s and created concerns about the ability of Fannie Mae and Freddie Mac to manage their portfolios of assets?
A)Fannie Mae miscalculated the value of its mortgages that created a restatement of its stockholder equity.
B)Both agencies overcharged lenders for services they provided.
C)Fannie Mae operated for some time with a sharp increase in interest rate risk on its balance sheet.
D)All of the above.
E)Answers B and C only.

Accepted Answer

All of the factors listed occurred in the early 2000s and created concerns about the ability of Fannie Mae and Freddie Mac to manage their portfolios of assets.

Question 9

26-81 Why are the regular GNMA pass-throughs not very attractive to insurance companies and pension funds seeking long-term duration assets to match their long-term duration liabilities?
A)Because of their short expected duration.
B)Because these bonds have the shortest average life with a maximum of prepayment protection.
C)Because they are zero coupon bonds and hence carry maximum amount of risk.
D)Because of their failures to offer prepayment protection.
E)Bondholders receive the promised coupon and principal payments but are not entitled to accrued interest payments.

Accepted Answer

Because of their failures to offer prepayment protection.

Question 10

26-76 A claim to the present value of the interest payments made by the mortgage holders in a GNMA pool is
A)a CARS.
B)an IO strip.
C)a CARD.
D)a PO strip.
E)a prepayment claim.

Accepted Answer

An IO (Interest-Only) strip represents a claim to the interest payments made by mortgage holders, which is separate from the principal payments.

Question 11

26-63 The Government National Mortgage Association
A)is a private corporation owned by shareholders.
B)purchases pools of mortgages originated by FIs.
C)provides timing insurance to investors in mortgage-backed securities.
D)only approves conventional and FHA/VA insured mortgages.
E)was the first agency to securitize residential mortgages.

Accepted Answer

The Government National Mortgage Association (Ginnie Mae) provides timing insurance to investors in mortgage-backed securities, ensuring timely payment of principal and interest.

Question 12

26-79 Which of the following best explains the term burn-out factor?
A)The percent of mortgage contract that is transferred from the seller to the buyer of a house.
B)The required interest spread of a pass-through security over a treasury when prepayment risk is taken into account.
C)The aggregate percent of the mortgage pool that has been prepaid prior to the month under consideration.
D)A mortgage-backed bond issued in multiple classes or tranches.
E)Bonds collateralized by a pool of assets.

Accepted Answer

Burn-out factor refers to the percentage of the mortgage pool that has been prepaid prior to the month under consideration. It indicates how much of the original mortgage pool remains and the potential risk of prepayment.

Question 13

26-77 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.
A)PO strip.
B)IO strip.
C)Class B bonds
D)Class Z bonds
E)Class A bonds

Accepted Answer

An IO strip is an example of a negative duration asset, meaning that its price moves in the opposite direction to changes in interest rates. As such, it can provide a valuable portfolio-hedging device for an FI manager, particularly when included with regular bonds whose price-yield curves show the normal inverse relationship. Options A, C, D, and E are not negative duration assets and therefore do not fit the description provided in the question.

Question 14

26-71 The characteristics of a CMO securities issue include the following EXCEPT
A)the tranches will have different coupon rates.
B)the CMO securities are insured separately from the GNMA pass-through securities.
C)the principal payments are made totally to the earliest remaining tranche.
D)GNMA pass-through securities are used as collateral in a trust to support the CMOs.
E)the CMO securities are split into different tranches or groupings.

Accepted Answer

CMO securities are not insured separately from the GNMA pass-through securities.

Question 15

26-70 Servicing a pass?through security refers to
A)an FI processing of all payments.
B)an FI provision of clearing services to set up the pass?through.
C)broker/dealer services provided by the FI to the ultimate holders of the pass?through.
D)guarantee by the FI of all principal and interest payments.
E)an FI provision of liquidity services to the ultimate holders of the pass?through.

Accepted Answer

The answer of 26-70 Servicing a pass?through security refers to
A)an...

Question 16

26-73 Which of the following good news and bad news effect is NOT true when mortgage interest rates decline,resulting in faster repayments?
A)Lower market yields reduce the discount rates on any mortgage cash flows and increase the present value of any given stream of cash flows (good news effect).
B)Low yields lead to faster prepayment of the mortgage pool's principal (good news effect).
C)With early prepayments comes fewer interest payments in absolute terms (bad news effect).
D)Faster cash flows due to prepayments can only be reinvested at lower interest rates (bad news effect).
E)Faster cash flows due to prepayments can be reinvested at higher interest rates (good news effect).

Accepted Answer

When mortgage interest rates decline, resulting in faster repayments, the faster cash flows due to prepayments can be reinvested at higher interest rates, which is a good news effect. Option A is also a good news effect because lower market yields increase the present value of mortgage cash flows. Option B is a good news effect because low yields lead to faster prepayment of the mortgage pool's principal. Option C and D are bad news effects because fewer interest payments and lower reinvestment rates limit the potential returns of investors.

Question 17

26-69 Which of the following is the principle source of prepayment risk on a typical FNMA mortgage-backed pass-through security?
A)Refinancing.
B)Default risk.
C)Housing turnover.
D)Non-assumable mortgages.
E)All of the above.

Accepted Answer

Prepayment risk on a typical FNMA mortgage-backed pass-through security is primarily driven by refinancing, housing turnover, and non-assumable mortgages.

Question 18

26-65 Which of the following is an incentive to securitize mortgage assets?
A)To reduce the regulatory tax burden on the FI.
B)To adjust the gap exposure of the FI.
C)To improve the liquidity of the FI.
D)To generate non-interest sensitive fee income.
E)All of the above.

Accepted Answer

All of the given options are incentives for financial institutions to securitize mortgage assets. By securitizing mortgage assets, FIs can reduce regulatory tax burden, adjust gap exposure, improve liquidity and generate fee income that is not interest-sensitive.

Question 19

26-82 In regard to a CMO,which of the following have the shortest average life with a minimum of prepayment protection?
A)Class A bonds.
B)Class B bonds.
C)Class C bonds.
D)Class Z bonds.
E)Class R bonds.

Accepted Answer

Class A bonds in a CMO structure typically have the shortest average life and the least prepayment protection, as they are the first to receive principal payments.

Question 20

26-64 On September 7,2008,both FHMA and FHLMC were placed under conservatorship by the
A)Federal Reserve.
B)Federal Housing Finance Agency.
C)Federal Deposit Insurance Corporation.
D)Federal Home Loan Bank.
E)Comptroller of the Currency.

Accepted Answer

The Federal Housing Finance Agency (FHFA) is the agency responsible for regulating and overseeing FHMA and FHLMC. On September 7, 2008, FHMA and FHLMC were placed under conservatorship by the FHFA due to the financial crisis and their deteriorating financial condition.

Quiz 26: Securitization

26-78 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?

26-67 Which of the following are functions of GNMA?

26-68 Which is the oldest mortgage-backed security sponsoring agency?

26-74 Which of the following is NOT a factor that may cause the prepayment risk on a pool of mortgages to differ from the PSA's assumed pattern?

26-75 Mortgage-backed bonds (MBB) differ from pass-throughs and CMOs in which of the following ways?

26-80 Which of the following is true concerning an assumable mortgage?

26-72 Investors in mortgage-backed pass-through securities are exposed to a variety of risks.Compared to other fixed-income securities,the most unique of these risks is

26-66 Which of the following factors occurred in the early 2000s and created concerns about the ability of Fannie Mae and Freddie Mac to manage their portfolios of assets?

26-81 Why are the regular GNMA pass-throughs not very attractive to insurance companies and pension funds seeking long-term duration assets to match their long-term duration liabilities?

26-76 A claim to the present value of the interest payments made by the mortgage holders in a GNMA pool is

26-63 The Government National Mortgage Association

26-79 Which of the following best explains the term burn-out factor?

26-77 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.

26-71 The characteristics of a CMO securities issue include the following EXCEPT

26-70 Servicing a pass?through security refers to

26-73 Which of the following good news and bad news effect is NOT true when mortgage interest rates decline,resulting in faster repayments?

26-69 Which of the following is the principle source of prepayment risk on a typical FNMA mortgage-backed pass-through security?

26-65 Which of the following is an incentive to securitize mortgage assets?

26-82 In regard to a CMO,which of the following have the shortest average life with a minimum of prepayment protection?

26-64 On September 7,2008,both FHMA and FHLMC were placed under conservatorship by the