土豆妮

Identify three risks associated with investing in mortgage-backed securities (MBS). Risks associated with investing in MBS are:

A) interest rate risk, default risk, and prepayment risk.

B) interest rate risk, contraction risk, and servicing fee risk.

C) extension risk, credit risk, and downgrade risk.

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A mortgage is a loan that is collateralized with a specific piece of real property, either residential or commercial. The borrower must make a series of mortgage payments over the life of the loan, and the lender has the right to “foreclose” or lay claim against the real estate in the event of a loan default. An MBS represents a claim against a pool of mortgages. The cash flows from the pool are distributed amongst the holders of all the MBS as per the terms of the issue.

Risks associated with investment in MBS:

• Interest rate risk?changes in the value of the MBS as interest rates change (usually inverse).
• Default risk?risk that some or all of the borrowers default and the collateral is not enough to cover the entire mortgage.
• Prepayment risk?risk that the borrowers prepay as interest rates decline.

土豆妮

Which of the following factors does NOT affect prepayments?

A) Housing turnover.

B) Defeasance.

C) Characteristics of the underlying mortgage pool.

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Defeasance is a type of call protection used in commercial loans.

土豆妮

Which of the following best describes how a growing economy can affect prepayments? A growing economy:

A) leads to increasing prepayments.

B) does not affect prepayments.

C) leads to decreasing prepayments.

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The reason for this link is as follows: A growing economy leads to a rise in personal income and opportunities for worker migration and mobility. This results in higher housing turnover and therefore increasing prepayment rates.

土豆妮

Which of the following most accurately describes prepayments?

A) A payment made in excess of the monthly mortgage payment.

B) A payment that pays the mortgage in full prior to maturity.

C) Prepayment occurs if both interest and principal are paid before the end of the mortgage term.

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It is possible for a mortgage borrower to pay an amount in excess of the required payment or even to pay off the loan entirely. Payments in excess of the required monthly amount are called prepayments.