CMA Mortgage-Backed Securities Overview 2 — Questions and Answers
Question 1: Which federal agency guarantees timely payment of principal and interest on mortgage-backed securities?
- Fannie Mae
- Freddie Mac
- Ginnie Mae (Correct answer)
- Sallie Mae
Correct answer: Ginnie Mae
Ginnie Mae (GNMA) is the only MBS guarantor backed by the full faith and credit of the U.S. government.
Question 2: What is the primary risk that MBS investors face when interest rates decline significantly?
- Extension risk
- Prepayment risk (Correct answer)
- Credit risk
- Liquidity risk
Correct answer: Prepayment risk
When rates fall, homeowners refinance, causing early principal return to MBS investors who must reinvest at lower yields — this is prepayment risk.
Question 3: In a pass-through MBS, how are principal and interest payments distributed to investors?
- Equally among all tranches
- Based on seniority hierarchy
- Pro-rata based on ownership percentage (Correct answer)
- Only after servicer fees are deducted last
Correct answer: Pro-rata based on ownership percentage
In a pass-through structure, all investors receive their proportional share of principal and interest payments after servicer fees.
Question 4: What term describes the difference between the coupon rate on an MBS and the underlying mortgage rates?
- Net interest margin
- Guaranty fee spread
- Servicing spread (Correct answer)
- Gross WAC
Correct answer: Servicing spread
The servicing spread (or servicing fee) is the portion of mortgage interest retained by the servicer before passing the remainder to MBS investors.
Question 5: Which measure represents the weighted average of the remaining terms to maturity of mortgages in an MBS pool?
- Weighted Average Coupon (WAC)
- Weighted Average Maturity (WAM) (Correct answer)
- Weighted Average Loan Age (WALA)
- Duration
Correct answer: Weighted Average Maturity (WAM)
WAM is the weighted average of remaining loan terms in the pool, indicating how long the pool's mortgages have left to run.
Question 6: A CMO's planned amortization class (PAC) tranche provides investors with protection against which two risks?
- Credit risk and market risk
- Prepayment risk and extension risk (Correct answer)
- Liquidity risk and reinvestment risk
- Interest rate risk and default risk
Correct answer: Prepayment risk and extension risk
PAC tranches use support/companion tranches as buffers to absorb both faster-than-expected prepayments and slower-than-expected paydowns.
Question 7: Which entity is responsible for servicing loans in an MBS pool after securitization?
- The trustee
- The original lender only
- The mortgage servicer (Correct answer)
- Fannie Mae directly
Correct answer: The mortgage servicer
The mortgage servicer collects borrower payments, manages escrow, handles defaults, and remits funds to the MBS trust.
CMA Mortgage-Backed Securities Overview 2
Which federal agency guarantees timely payment of principal and interest on mortgage-backed securities?