CMA Mortgage-Backed Securities Overview 3 — Questions and Answers
Question 1: What does the PSA prepayment model assume about prepayment speeds in the first 30 months of a mortgage pool?
- Prepayments are constant throughout
- Prepayments ramp up from 0% CPR to 6% CPR linearly (Correct answer)
- Prepayments decrease as loans age
- Prepayments follow a fixed 6% CPR from issuance
Correct answer: Prepayments ramp up from 0% CPR to 6% CPR linearly
The PSA standard model assumes prepayments ramp up at 0.2% CPR per month for 30 months until reaching 6% CPR, then remain constant.
Question 2: Which type of MBS pools only adjustable-rate mortgages?
- GNMA I
- ARM MBS (Correct answer)
- Fixed-rate CMO
- TBA MBS
Correct answer: ARM MBS
ARM MBS (Adjustable-Rate MBS) are securitizations backed exclusively by adjustable-rate mortgage loans.
Question 3: In the TBA (To-Be-Announced) market, what is typically settled on trade settlement date?
- Only the coupon rate
- The specific pool identifiers, face value, and price (Correct answer)
- Only the originator's identity
- Only the maturity date
Correct answer: The specific pool identifiers, face value, and price
At TBA settlement, the seller announces the specific pool(s) — including CUSIP, face value, and price — that will be delivered to fulfill the forward trade.
Question 4: What is the effect of negative convexity on an MBS investment when interest rates fall sharply?
- Price increases faster than a comparable Treasury bond
- Price increases less than expected due to prepayments (Correct answer)
- Price remains unchanged due to government guarantee
- Price decreases alongside rates
Correct answer: Price increases less than expected due to prepayments
Negative convexity causes MBS prices to lag Treasury price gains when rates fall sharply, because accelerating prepayments cap the upside.
Question 5: Which CMO tranche receives no periodic interest payments but is sold at a deep discount and accretes to par?
- PAC tranche
- TAC tranche
- Z-tranche (accrual bond) (Correct answer)
- IO strip
Correct answer: Z-tranche (accrual bond)
The Z-tranche accrues interest that is added to principal balance until all preceding tranches are retired, then receives full cash flows.
Question 6: What is the primary difference between Fannie Mae MBS and Ginnie Mae MBS regarding credit risk?
- Fannie Mae MBS carry no credit risk; Ginnie Mae MBS carry full credit risk
- Ginnie Mae MBS carry explicit U.S. government guarantee; Fannie Mae MBS carry only GSE guarantee (Correct answer)
- Both carry identical U.S. Treasury guarantees
- Fannie Mae MBS are unguaranteed private-label securities
Correct answer: Ginnie Mae MBS carry explicit U.S. government guarantee; Fannie Mae MBS carry only GSE guarantee
Ginnie Mae's guarantee is backed by the full faith and credit of the U.S. government, while Fannie Mae's guarantee is a GSE obligation without direct Treasury backing.
Question 7: When analyzing MBS, what does the option-adjusted spread (OAS) measure?
- The spread before adjusting for any prepayment options
- The spread over Treasuries after removing the value of embedded prepayment options (Correct answer)
- The difference between the WAC and the coupon rate
- The yield premium over the benchmark only at issuance
Correct answer: The spread over Treasuries after removing the value of embedded prepayment options
OAS isolates the credit and liquidity spread of an MBS by stripping out the value of the borrower's embedded prepayment option.
CMA Mortgage-Backed Securities Overview 3
What does the PSA prepayment model assume about prepayment speeds in the first 30 months of a mortgage pool?