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LOS e, (Part 2): Explain the cash flow, prepayments, and prepayment risk for each type of mortgage-backed security.

Q1. A payment made that is in excess of the required monthly mortgage payment is called:

A)   prepayment risk.

B)   curtailment.

C)   prepayment.

Q2. When a prepayment is less than the entire outstanding principal amount it is called:

A)   prepayment risk.

B)   securitized.

C)   curtailment.

Q3. The risk that relates to the amount and timing of cash flows from a mortgage is known as:

A)   liquidity risk.

B)   prepayment risk.

C)   default risk.

Q4. If a prepayment of principal is for an amount that is less than the full outstanding balance of the loan, it is know as a(n):

A)   curtailment.

B)   participation.

C)   intermediate payment.

Q5. Which of the following statements concerning mortgage-backed securities is most accurate?

A)   As rates rise, mortgage-backed security holders face reinvestment risk.

B)   Collateralized Mortgage Obligations (CMOs) prioritize the interest payments on mortgages to different sets of investors.

C)   Curtailment of a mortgage is a prepayment of less than the full principal.

LOS e, (Part 2): Explain the cash flow, prepayments, and prepayment risk for each type of mortgage-backed security.fficeffice" />

Q1. A payment made that is in excess of the required monthly mortgage payment is called:

A)   prepayment risk.

B)   curtailment.

C)   prepayment.

Correct answer is C)

This is the definition of prepayment. Curtailment is when the prepayment is not for the entire amount. Prepayment risk is the risk that relates to the amount and timing of cash flows from a mortgage.

Q2. When a prepayment is less than the entire outstanding principal amount it is called:

A)   prepayment risk.

B)   securitized.

C)   curtailment.

Correct answer is C)

Curtailment is when the prepayment is not for the entire amount. Prepayment risk is the risk that relates to the amount and timing of cash flows from a mortgage.

Q3. The risk that relates to the amount and timing of cash flows from a mortgage is known as:

A)   liquidity risk.

B)   prepayment risk.

C)   default risk.

Correct answer is B)        

Default risk is the risk that the borrower will not pay back the amounts borrowed. Liquidity risk deals with the ability to sell a security easily at a fair price.

Q4. If a prepayment of principal is for an amount that is less than the full outstanding balance of the loan, it is know as a(n):

A)   curtailment.

B)   participation.

C)   intermediate payment.

Correct answer is A)        

If a prepayment of principal is for an amount that is less than the full outstanding balance of the loan, it is know as a curtailment.

Q5. Which of the following statements concerning mortgage-backed securities is most accurate?

A)   As rates rise, mortgage-backed security holders face reinvestment risk.

B)   Collateralized Mortgage Obligations (CMOs) prioritize the interest payments on mortgages to different sets of investors.

C)   Curtailment of a mortgage is a prepayment of less than the full principal.

Correct answer is C)

Curtailment of a mortgage is a prepayment of less than full principal. The other statements are false. Holders of mortgage-backed securities face reinvestment risk as rates decline. Also, CMO’s prioritize the principal payments on mortgages to different sets of investors – all tranches receive interest payments, but each successive tranche does not receive principal payments until the first is paid off.

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