Reading 57: Valuing Mortgage-Backed and Asset-Backed Securit 2010, security, center, style, label

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Session 15: Fixed Income: Structured Securities
Reading 57: Valuing Mortgage-Backed and Asset-Backed Securities

LOS a, (Part 1): Illustrate the computation, use, and limitations of the cash flow yield for a mortgage-backed security (MBS) and an asset-backed security (ABS).

 

 

 

Which of the following is a difference between agency and nonagency mortgage-backed securities (MBS) in the calculation of the cash flow yield? For nonagency MBSs:

A) the principal is variable.

B) an assumption about the prepayment rate has to be made.

C) an assumption about default rates has to be made.

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Nonagency MBSs are not insured against default risk.

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Which of the following is a limitation of the cash flow yield measure? The cash flow yield measure:

A) assumes that interest rates do not change over the life of the security.

B) assumes a flat yield curve.

C) assumes that the projected cash flows are reinvested at the cash flow yield.

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Cash flow yield has two major deficiencies: (i) it is implicitly assumed that the cash flows will be reinvested at the cash flow yield prevailing when the MBS or ABS is priced, and (ii) it is assumed that the MBS or ABS will be held until maturity.

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All of the following are limitations of the cash flow yield EXCEPT:

A) it assumes cash flows will be realized.

B) it is assumed that the MBS or ABS will be held to maturity.

C) the cash flow yield can never be as high as the comparable corporate bond yield due to prepayments.

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It assumes cash flows will be realized and the security will be held to maturity.

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The assumption that the cash flows will be received is:

A) more reasonable for a mortgage-backed security (MBS) or an asset-backed security (ABS) than for many other fixed-income securities.

B) less reasonable for a mortgage-backed security (MBS) or an asset-backed security (ABS) than for many other fixed-income securities.

C) equally as reasonable for a mortgage-backed security(MBS) or an asset-backed security (ABS) than for many other fixed-income securities.

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The assumption that the cash flows will be received is less reasonable for an MBS or an ABS than for many other fixed-income securities because of prepayments.

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Which of the following is a problem with computing the cash flow yield of an agency mortgage-backed security?

A) There is interest rate risk.

B) The cash flows are unknown.

C) There is default risk.

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The cash flows are unknown because of prepayments.

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The discount rate that makes the price of a mortgage or asset-backed security equal to the present value of its cash flows is called the:

A) cash flow yield.

B) mortgage-backed yield.

C) asset-backed yield.

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The discount rate that makes the price of a mortgage or asset-backed security equal to the present value of its cash flows is called the cash flow yield.

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Regarding the computation of the cash flow yield for an agency security, which of the following is the best reason why the assumption that the projected cash flows are actually realized is very restrictive?

A) Prepayments.

B) Interest rate risk.

C) Default risk.

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Prepayments instill uncertainty into the assumed cash flows used to compute cash flow yield.