Reading 58: LOS f ～ Q6- 10

6.Which of the following best describes prepayment risk?

A)   The risk associated with the unknown amount and timing of cash flow's resulting from prepayments.

B)   The lender's spread risk resulting from prepayments.

C)   The lender's interest rate risk resulting from prepayments.

D)   The risk associated with the probability of default resulting from prepayments.

The correct answer was A)

Mortgage prepayments reduce the amount of interest the lender receives over the life of the loan. The likelihood of this situation actually occurring is very real and is known as prepayment risk.

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

A)   does not affect prepayments.

B)   leads to decreasing prepayments.

C)   leads to increasing prepayments.

D)   leads to increasing or decreasing prepayments.

The correct answer was C)

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.

8.Which of the following factors does NOT affect prepayments?

A)   Seasonal factors.

B)   The prevailing mortgage rate.

C)   Characteristics of the underlying mortgage pool.

D)   The time to maturity of the mortgage-backed security.

The correct answer was D)

The remaining life of the individual loans affect prepayments but not the life of the mortgage-backed security.

9.All of the following mortgage loan characteristics affect prepayments EXCEPT:

A)   original mortgage rate.

B)   amount of seasoning.

C)   type of loan (e.g., 30-year fixed rate, 15-year variable).

D)   reputation of the lender with the agencies (e.g., Fannie Mae, Ginnie Mae).

The correct answer was D)

The reputation of the lender does not affect prepayments.

10.All of the following are factors that affect prepayments EXCEPT:

A)   the amount of overall mortgage loan activity in the market.

B)   prevailing mortgage rates.

C)   seasoning.

D)   characteristics of underlying mortgage loans.

The correct answer was A)

The amount of overall mortgage activity does not impact prepayments.