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 default rates has to be made.
C)
an assumption about the prepayment rate has to be made.
Nonagency MBSs are not insured against default risk.作者: cross-ied 时间: 2012-4-2 18:49
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 that the projected cash flows are reinvested at the cash flow yield.
C)
assumes a flat yield curve.
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.作者: cross-ied 时间: 2012-4-2 18:50
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.
It assumes cash flows will be realized and the security will be held to maturity.作者: cross-ied 时间: 2012-4-2 18:50
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)
equally as reasonable for a mortgage-backed security(MBS) or an asset-backed security (ABS) than for many other fixed-income securities.
C)
less reasonable for a mortgage-backed security (MBS) or an asset-backed security (ABS) than for many other fixed-income securities.
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.作者: cross-ied 时间: 2012-4-2 18:50
Which of the following is a problem with computing the cash flow yield of an agency mortgage-backed security?
A)
The cash flows are unknown.
B)
There is interest rate risk.
C)
There is default risk.
The cash flows are unknown because of prepayments.作者: cross-ied 时间: 2012-4-2 18:51
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)
mortgage-backed yield.
B)
cash flow yield.
C)
asset-backed yield.
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.作者: cross-ied 时间: 2012-4-2 18:51
Paul Wilken works in the structured-product group of a large investment bank. One of his new tasks is to perform valuation analysis on mortgage-backed and asset-backed securities. Wilken has not worked with mortgage-backed securities (MBS) or asset-backed securities (ABS) in several years, so he takes some time to reacquaint himself with the many measures used to value these types of securities.
Wilken begins with the cash flow yield. He believes the cash flow yield is of little use in real-life situations. He records the following assumptions of the cash flow yield.
All cash flows will come in on schedule.
All interim cash flows are reinvested at the cash flow yield.
Default risk associated with the underlying loans is constant over the life of the security.
Mortgage-backed or asset-backed securities are held until the final payout.
Wilken then turns his attention to the nominal spread, which he finds more useful than the cash flow yield.
After reviewing the basics, Wilken begins work on his valuations. He has some experience using interest-rate lattice models to price interest-rate derivatives. However, he has read that the lattice-based backward-induction method cannot be used to value mortgage-backed securities (MBS). Instead, he considers the merits of zero-volatility spreads and Monte Carlo simulations.
Wilken begins his bond-valuation assignment by considering two securities – a bond backed by credit-card loans, and a bond backed by home-equity loans.
Wilken assigns a junior researcher, Michelle Zoellick, to help with his bond valuations. Her first job is to determine the effective durations of a series of bonds. Zoellick soon realizes that all of the dealers used by the investment bank provide different estimates for effective duration. She tries to determine why this is so, and concludes that the numbers are not equal because vendors use different assumptions for:
Prepayment assumptions
Option-adjusted spreads (OASs)
Credit risk
Interest-rate volatility
Which of the following spreads are best used to value the asset-backed securities below?
Credit-card ABS
Home-equity loan ABS
A)
Z-spread
OAS
B)
OAS
OAS
C)
Z-spread
Z-spread
Credit-card loans do not have prepayment options, and as such can be valued using the zero-volatility spread, which does not take options into account. Bonds backed by home-equity loans do have prepayment risk, and as such require an option-adjusted spread. (Study Session 15, LOS 53.i) Which of the following assumptions is least likely a limitation of the cash flow yield measure?
A)
MBS or ABSs are held until the final payout.
B)
All cash flows will come in on schedule.
C)
Default risk associated with the underlying loans is constant over the life of the security.
The cash flow yield measure does not rely on any credit risk assumption. The other assumptions apply to the cash flow yield, and all represent a weakness of the metric, because they are not practical in a real-life context. (Study Session 15, LOS 53.a) Which of the following is least likely a reason why effective duration estimates differ from vendor to vendor?
A)
Prepayment assumptions.
B)
OAS.
C)
Credit risk.
Credit risk is generally built into a bond’s yield and price, and no estimates of it are needed to compute effective duration. The other assumptions can differ from vendor to vendor and result in different quote for effective duration. (Study Session 15, LOS 53.f) Which of the following statements about the nominal spread is most accurate relative to MBSs?
A)
A portion of the spread reflects prepayment risk.
B)
The nominal spread and the Z-spread begin to converge when the yield curve steepens.
C)
Nominal spreads can only be calculated using a Monte Carlo simulation.
The nominal spread includes some compensation for prepayment risk, but investors cannot tell how much of the spread reflects that risk. Analysts can calculate nominal spreads without a Monte Carlo simulation. The difference between the nominal and zero-volatility spreads widens when the slope of the yield curve increases. (Study Session 15, LOS 53.a) Which of the following is a reason why the lattice-based backward-induction method is ineffective for valuing a MBS. The method cannot handle:
A)
the path dependency of cash flows.
B)
variable interest rates.
C)
call options.
MBS prepayments depend on the level of the interest rate at a particular point in time and also on the path the interest rate has taken in order to get to a certain level. Backward induction can't easily capture path-dependent cash flows, and as such is not useful for predicting prepayments. Backward induction can account for call options and variable interest rates. (Study Session 15, LOS 53.c) Which of the following statements about Monte Carlo simulations is least accurate?
A)
The simulations can compensate for prepayment burnout.
B)
The simulations determine value by adding the zero-volatility spread to every spot rate along every interest-rate path.
C)
Effective models must include assumptions about interest-rate paths, rate volatility, benchmark interest rates, and prepayments.
Monte Carlo simulations add the OAS to every spot rate. The other statements are true. (Study Session 15, LOS 53.d)作者: cross-ied 时间: 2012-4-2 18:52
Which of the following is a difficulty in valuing collateralized mortgage obligations (CMOs) using Monte Carlo simulation or any other methodology? The issuer has distributed:
A)
both the prepayment risk and interest rate risk equally into different tranches.
B)
both the prepayment risk and interest rate risk unequally into different tranches.
C)
the prepayment risk into different tranches.
Some of the tranches are more sensitive to prepayment risk and interest rate risk than the collateral, while others are much less sensitive.作者: cross-ied 时间: 2012-4-2 18:53
Which of the following statements concerning Monte Carlo simulation for valuing a mortgage-backed security is CORRECT? Monte Carlo simulation involves:
A)
generating a series of interest rates paths used to discount the known cash flows.
B)
generating a series of cash flows based on simulated mortgage refinancing rates.
C)
creating a binomial interest rate tree that is used for the valuation.
Monte Carlo simulation makes use of an interest rate model to generate a mortgage refinancing rates for each month along each of a set of simulated interest rate paths. These refinancing rates along with mortgage loan characteristics are then fed into a prepayment model that estimates a prepayment rate for each month along each path. With these prepayment rate projections, monthly cash flows can be estimated.作者: cross-ied 时间: 2012-4-2 18:53
All of the following are steps used in applying a Monte Carlo simulation model for valuing a mortgage-backed security (MBS) EXCEPT:
A)
input potential interest rate paths.
B)
stipulate the number of paths the analyst is willing accept.
C)
use the Treasury yield curve for rates.
To use Monte Carlo simulation, you do not need to stipulate the number of paths you would be willing to accept.作者: cross-ied 时间: 2012-4-2 18:53
The volatility assumption in a Monte Carlo simulation is important, because it determines the:
A)
speed of prepayments.
B)
level of prepayments.
C)
dispersion of future interest rates and the number of possible paths that may be followed.
The volatility assumption in a Monte Carlo simulation is important because it determines the dispersion of future interest rates and the number of possible paths that may be followed.作者: cross-ied 时间: 2012-4-2 18:53
Which of the following statements regarding a mortgage-backed security (MBS) is CORRECT?
A)
Backward induction methodology is useful for valuing MBS.
B)
Binomial models should not be used for MBS because of path dependency.
C)
Path dependency means that MBS prices tend to follow a trend.
In a MBS, whether a mortgage is called depends on the path of previous interest rates. If rates had been low previously, then mortgages are less likely to be called later on. Thus a binomial model that uses backward induction methodology (later outcomes are determined first) should not be used to value MBS.作者: cross-ied 时间: 2012-4-2 18:54
Assume that interest rates in the year 2010 decrease below historical averages. They continue their downward trend for years 2011 and 2012. In which year would a MBS be least likely to be experience high rates of prepayment?
A)
2012.
B)
2013.
C)
2010.
In a mortgage-backed security (MBS), whether a mortgage is called depends on the path of previous interest rates. If rates have been on a downward trend, then fewer mortgages will be refinanced as the trend continues because homeowners that have wanted to refinance will have already done so. Thus fewer mortgages will be refinanced in the year 2012 than in the earlier years.作者: cross-ied 时间: 2012-4-2 18:54
Prepayment burnout in a mortgage-backed security (MBS) refers to the fact that:
A)
some tranches will experience extreme rates of prepayment.
B)
in the later years of a downward trend in interest rates, fewer mortgages will be refinanced.
C)
eventually a MBS will exceed the maximum prepayments allowed when interest rates drop too low.
In a MBS, whether a mortgage is called depends on the path of previous interest rates. If rates have been on a downward trend, then fewer mortgages will be refinanced as the trend continues because homeowners that have wanted to refinance will have already done so. Prepayment burnout means that eventually mortgage refinancing will slow in the later stages of a downward trend in interest rates.作者: LiquidAssets10 时间: 2012-4-2 18:55
How is the option-adjusted spread (OAS) computed using the Monte Carlo simulation model? The OAS is the value of the spread that, when added to all of the simulated spot rates, makes the:
A)
average of the present values from the simulated cash flow paths equal to the market price of the mortgage-backed security.
B)
present value of cash flows equal to the market price of the mortgage-backed security.
C)
theoretical present value, assuming a constant prepayment rate, equal to the market price of the mortgage-backed security.
The option adjusted spread for the Monte Carlo model is the spread that must be added to all of the spot rates along each interest rate path that will make the average present value of the path cash flows equal to the market price (plus accrued interest) for the MBSs being evaluated.作者: LiquidAssets10 时间: 2012-4-2 18:56
If the simulated interest rates are based on the Treasury curve, then how is the option-adjusted spread obtained (OAS) using the Monte Carlo simulation model interpreted? The OAS is the:
A)
spread over the Treasury spot rate corresponding to the maturity of the mortgage-backed security.
B)
average spread over the Treasury yield.
C)
average spread over the Treasury spot rate curve.
The monthly rates along the paths generated with the Monte Carlo simulation model using the Treasury yield curve as a benchmark are Treasury spot rates that have been adjusted to be arbitrage-free. As such, the OAS measures the average spread over Treasury spot rates, not the Treasury yield.作者: LiquidAssets10 时间: 2012-4-2 18:56
The spread (k) that must be added to all of the spot rates along each interest rate path that will force equality between the average present value of the path’s cash flows and the market price (plus accrued interest) for the mortgage-backed security (MBS) being evaluated is called the:
A)
PAC spread.
B)
k-spread.
C)
option-adjusted spread (OAS).
The spread (k) that must be added to all of the spot rates along each interest rate path that will force equality between the average present value of the path’s cash flows and the market price (plus accrued interest) for the MBS being evaluated is called the OAS.作者: LiquidAssets10 时间: 2012-4-2 18:57
Wanda Brunner, CFA, is evaluating two tranches of a sequential-pay CMO structure.
Tranche
OAS (bps)
Z-spread (bps)
Effective duration
I
95
100
4.25
II
90
100
4.25
How should Brunner trade these CMO tranches?
A)
Buy Tranche II and sell Tranche I.
B)
Cannot be determined.
C)
Buy Tranche I and sell Tranche II.
Tranche I option cost = 100 – 95 = 5 basis points
Tranche II option cost = 100 – 90 = 10 basis pointsTranche I has a higher OAS and lower option cost than Tranche II, and the effective durations of the two tranches are equal. Therefore:
Tranche I is undervalued on a relative basis (“cheap”), and she should buy it.
Tranche II is overvalued on a relative basis (“rich”), and she should sell it.
作者: LiquidAssets10 时间: 2012-4-2 18:57
Generally speaking, an analyst would like the adjusted spread (OAS) to be:
A)
small.
B)
big.
C)
zero.
Generally speaking, an analyst would like the OAS to be big.作者: LiquidAssets10 时间: 2012-4-2 18:57
The major differences in effective duration among analytical systems providers are attributable to all of the following assumptions EXCEPT:
A)
option adjusted spread (OAS) differences.
B)
differences in changes in interest rates.
C)
mortgage-rate differences.
Mortgage rate differences do not cause effective duration differences among analytical system providers.作者: LiquidAssets10 时间: 2012-4-2 18:58
Paul Wilken works in the structured product group of a large investment bank. One of his new tasks is to perform valuation analysis on mortgage-backed (MBS) and asset-backed securities (ABS). Wilken needs to familiarize himself with the many measures used to value these types of securities. The first valuation metric that Wilken is to explore is the cash flow yield. Wilken would like to determine the strengths and weaknesses of the cash flow yield. Which of the following assumptions is least likely a limitation of the cash flow yield measure?
A)
The computation includes an assumption about the default rate of the underlying loans.
B)
The credit risk associated with the underlying loans is constant over the life of the security.
C)
MBS or ABSs are held until the final payout based on some prepayment assumption.
The cash flow yield measure does not rely on any credit risk assumption. (Study Session 15, LOS 53.a) Wilken now turns his attention to the nominal spread. Once again he is interested in the strengths and weaknesses of the valuation metric. Which of the following is a limitation of the nominal spread? The nominal spread:
A)
contains no adjustment for prepayment risk.
B)
is not adjusted for interest rate risk.
C)
does not account for inflation.
The nominal spread does not properly capture the prepayment risk associated with these securities. (Study Session 15, LOS 53.a) Wilken has some experience using interest rate lattice models to price interest rate derivatives. He has read that the lattice based backward induction method cannot be used to value a MBS. Which of the following is a reason why this is the case? The lattice based backward induction method is difficult to use because of:
A)
prepayments.
B)
variable interest rates.
C)
the path dependency of cash flows.
Prepayments depend on the level of the interest rate at a particular point in time and also on the path the interest rate has taken in order to get to a certain level. Backward induction can't easily capture path dependent cash flows.
Prepayments can be incorporated in a model that uses backward induction. (Study Session 15, LOS 53.c)
Wilken wants to use Monte Carlo simulation in order to value agency passthrough securities. Why must adjustments be made to interest rate paths of the Monte Carlo simulation model? Adjustments must be made to:
A)
ensure that the correct prepayments are included.
B)
produce the requisite no-arbitrage property.
C)
prevent defaults.
The user must adjust the interest rate paths so that the model retains a no-arbitrage with market values. (Study Session 15, LOS 53.b) Wilken turns his attention to interest rate sensitivity measures. In particular he wants to know why there are differences in effective duration quotes between dealer firms. Which of the following is least likely a reason why there exist differences in the effective duration measures in the MBS and ABS markets? Suppliers of effective duration quotes use different:
A)
OASs.
B)
prepayment models.
C)
convexity estimates.
The convexity metric is not needed to compute the effective duration. (Study Session 15, LOS 53.f) Wilken is aware that there are different methods to value an ABS. When should an ABS be valued using the zero-volatility spread approach?
A)
When the ABS does not have a prepayment option or the prepayment option is unlikely to be exercised.
B)
When the ABS has a prepayment option that is likely to be exercised.
C)
When there is no default risk.
This approach does not consider any prepayment option. (Study Session 15, LOS 53.i)作者: LiquidAssets10 时间: 2012-4-2 18:58
Which of the following is NOT a major reason why the effective durations reported by dealers and vendors can be very different?
A)
Differences in the assumption how yield volatility changes for shocks to the yield curve.
B)
Different option-adjusted spreads.
C)
Differences in the relationship between short-term interest rates and refinancing rates.
The major differences in the effective duration among analytical systems providers are attributable to differences in the following: the incremental change in interest rate, the prepayment model, the OAS, and the interest rate/refinancing rate spread assumption.作者: LiquidAssets10 时间: 2012-4-2 18:59
Why do differences in the size of the rate shock produce different effective durations?
A)
The yield curve is not flat.
B)
Different rate shocks result in different yield volatility changes.
C)
The price-yield relationship is convex.
If the incremental change in interest rates is too large, the effects of convexity contaminate duration measurements.作者: LiquidAssets10 时间: 2012-4-2 18:59
The option adjusted spread (OAS) is used to analyze risk by adjusting for the embedded options. Which of the following risks does the OAS reflect?
A)
Credit risk.
B)
Prepayment risk.
C)
Maturity risk.
The OAS reflects credit risk and liquidity risk.作者: LiquidAssets10 时间: 2012-4-2 18:59
All of the following are advantages of coupon curve duration EXCEPT it:
A)
presumably reflects market expectations.
B)
is easy to apply.
C)
is limited to generic mortgage-backed securities (MBS).
It is a disadvantage that it is limited to generic MBS and is not readily applicable to collateralized mortgage obligations (CMO) structures.作者: LiquidAssets10 时间: 2012-4-2 19:00
Which of the following is a limitation of cash flow duration?
A)
It assumes a single prepayment rate over the life of the mortgage backed security.
B)
It assumes that the cash flows do not change for a given interest rate shock.
C)
It does not take credit risk into account.
A major criticism of cash flow duration is that it is based on the unrealistic assumption that a single prepayment rate exists over the life of an MBS for any given change in interest rates. The Monte Carlo simulation does allow for changing prepayment rates, and, therefore, effective duration computed using the Monte Carlo simulation is much better than cash flow duration for MBSs作者: LiquidAssets10 时间: 2012-4-2 19:00
All of the following are disadvantages of empirical duration EXCEPT:
A)
the volatility of the spreads with reference to Treasuries can distort the price reaction to interest rate changes.
B)
time series data on mortgage-backed securities may be difficult to obtain.
C)
it has no theoretical underpinnings or analytical assumptions.
The fact that it has no theoretical underpinnings or analytical assumptions is an advantage of empirical duration, not a disadvantage.作者: LiquidAssets10 时间: 2012-4-2 19:00
Which of the following is least likely an advantage of the empirical duration approach?
A)
The volatility of the spread to Treasury securities does not distort how the price of mortgage-backed securities (MBS) reacts to yield changes.
B)
The only inputs needed are prices and Treasury yields.
C)
It does not rely on any theoretical formulas or assumptions.
The fact that the volatility of the spreads with reference to Treasuries can distort the price reaction to interest rate changes is a criticism of the empirical duration approach.作者: LiquidAssets10 时间: 2012-4-2 19:01
The cash flows from mortgage-backed and some asset-backed securities are:
A)
virtually free of prepayment risk.
B)
interest rate path dependent.
C)
interest rate path independent.
The cash flows from mortgage-backed and some asset-backed securities are interest-rate path dependent.作者: LiquidAssets10 时间: 2012-4-2 19:01
For a bond with an embedded option where the cash flows are not interest rate path dependent, which of the following valuation approaches should be used?
A)
The option-adjusted spread approach with the binomial model.
B)
The zero-volatility spread approach with the binomial model.
C)
The option-adjusted spread approach with the Monte Carlo simulation model.
The OAS method recognizes that cash flow changes accompany interest rate changes. Thus, it is suitable to use OAS analysis with ABSs that have a prepayment option that is frequently exercised, and if the cash flows are independent of the interest rate path, OAS should be computed with the binomial model.作者: LiquidAssets10 时间: 2012-4-2 19:01
With the zero volatility spread (Z-spread) approach the value of an asset-backed security (ABS) is the present value of cash flows discounted at the spot rates plus the Z-spread. This means the Z-spread technique does not incorporate prepayments and thus would be appropriate to value:
A)
high quality home equity loans.
B)
auto loans or credit card loans.
C)
auto loans or high quality home equity loans.
The Z-spread would be appropriate for valuing auto or credit card backed securities, because neither are likely to refinance.作者: LiquidAssets10 时间: 2012-4-2 19:02
When should an asset-backed security (ABS) be valued using the option-adjusted spread (OAS) approach?
A)
To value ABS that have a prepayment option.
B)
To value ABS that do not have a prepayment option.
C)
For agency ABS.
The OAS method recognizes that cash flow changes accompany interest rate changes. Thus, it is suitable to use OAS analysis with ABSs that have a prepayment option that is frequently exercised, e.g., high quality home equity loans.作者: LiquidAssets10 时间: 2012-4-2 19:02
When is it best for an asset-backed security (ABS) to be valued using the zero-volatility spread approach?
A)
To value ABS that have a prepayment option.
B)
To value ABS that do not have a prepayment option.
C)
For agency ABS.
With the zero-spread method, the value of an ABS is the present value of its cash flows discounted at the spot rates plus the zero-volatility spread. The Z-spread technique does not incorporate prepayments. Thus, it should only be used for ABSs for which the borrower either has no option to prepay, or is unlikely to.作者: LiquidAssets10 时间: 2012-4-2 19:02
For a bond with an embedded option where the cash flow is interest rate path dependent, which of the following valuation approaches should be used?
A)
The nominal spread approach with the Monte Carlo simulation model.
B)
The option-adjusted spread approach with the binomial model.
C)
The option-adjusted spread approach with the Monte Carlo simulation model.
The OAS method recognizes that cash flow changes accompany interest rate changes. Thus, it is suitable to use OAS analysis with ABSs that have a prepayment option that is frequently exercised, and, if the cash flows are dependent upon the interest rate path, OAS should be computed with the Monte Carlo simulation model.作者: LiquidAssets10 时间: 2012-4-2 19:03
The nominal spread is the spread between the cash flow yield and the yield on a Treasury security with the same maturity as the average life of the mortgage-backed security (MBS) or asset-backed security (ABS) under analysis. For MBS and ABS the nominal spread:
A)
has nothing to do with prepayment risk.
B)
assumes no prepayment risk.
C)
masks the fact that a portion of the spread is compensation for accepting prepayment risk.
For MBS and ABS, the nominal spread masks the fact that a portion of the spread is compensation for accepting prepayment risk.作者: LiquidAssets10 时间: 2012-4-2 19:03
For a bond with an embedded option, if cash flows are independent of past interest rates, or not path dependent the:
A)
Z-spread should be used with the binomial model.
B)
option adjusted spread (OAS) should be used with the Monte Carlo simulation model.
C)
option adjusted spread (OAS) should be used with the binomial model.
If cash flows are independent of past interest rates, or not path dependent, the OAS should be used with the binomial model.
