CMPS Financial and Housing Markets 3 — Questions and Answers
Question 1: What happens to the price of an existing mortgage-backed security when market interest rates rise?
- Its price rises because income streams become more valuable
- Its price falls because its fixed yield becomes less attractive (Correct answer)
- Its price is unaffected because payments are contractually fixed
- Its price rises to match the new rate environment
Correct answer: Its price falls because its fixed yield becomes less attractive
Like all fixed-income securities, MBS prices move inversely to interest rates — rising rates make existing fixed-payment MBS less attractive, pushing prices down.
Question 2: What is 'prepayment risk' in the context of mortgage-backed securities?
- The risk that borrowers will default before the loan matures
- The risk that borrowers will pay off loans early, reducing expected interest income (Correct answer)
- The risk that servicers will not remit payments on time
- The risk that property values will fall below the loan balance
Correct answer: The risk that borrowers will pay off loans early, reducing expected interest income
Prepayment risk is the uncertainty that borrowers will refinance or pay off their mortgages early, cutting off the interest income that MBS investors expected.
Question 3: Which of the following best describes a 'buyer's market' in residential real estate?
- Low inventory relative to buyer demand, pushing prices up
- High inventory relative to buyer demand, giving buyers negotiating power (Correct answer)
- A market where only cash buyers can compete successfully
- A period when mortgage rates are below the historic average
Correct answer: High inventory relative to buyer demand, giving buyers negotiating power
A buyer's market occurs when supply of homes exceeds demand, allowing buyers to negotiate lower prices, request concessions, and take more time to decide.
Question 4: The 'absorption rate' in a housing market refers to:
- The percentage of mortgages absorbed by the secondary market
- The rate at which available homes are sold over a given period (Correct answer)
- The speed at which new construction permits are issued
- The proportion of income absorbed by housing costs
Correct answer: The rate at which available homes are sold over a given period
Absorption rate measures how quickly existing inventory is sold, typically expressed as months of supply; lower rates indicate stronger demand relative to supply.
Question 5: What is the role of the Government National Mortgage Association (Ginnie Mae) compared to Fannie Mae?
- Ginnie Mae is privately owned while Fannie Mae is a government agency
- Ginnie Mae guarantees MBS backed by government-insured loans (FHA/VA); Fannie Mae deals with conventional loans (Correct answer)
- Ginnie Mae insures individual loans while Fannie Mae insures pools
- They have identical roles but serve different geographic regions
Correct answer: Ginnie Mae guarantees MBS backed by government-insured loans (FHA/VA); Fannie Mae deals with conventional loans
Ginnie Mae is a true government agency that guarantees timely payment on MBS backed by FHA, VA, and USDA loans, while Fannie Mae works with conventional conforming loans.
Question 6: How does the concept of 'housing affordability' typically combine multiple economic factors?
- It uses only median home prices and median household income
- It factors in median home prices, median income, and prevailing mortgage rates (Correct answer)
- It measures the percentage of renters who can qualify for ownership
- It is based solely on the monthly principal and interest payment
Correct answer: It factors in median home prices, median income, and prevailing mortgage rates
Affordability indices such as the NAR Housing Affordability Index incorporate median home prices, median family income, and current mortgage rates to assess purchasing power.
Question 7: What effect does a surplus of foreclosed properties ('shadow inventory') typically have on a local housing market?
- It stabilizes prices by ensuring a steady supply of affordable homes
- It tends to depress property values and slow price recovery (Correct answer)
- It increases demand from investors, raising prices quickly
- It has no measurable effect on median home prices
Correct answer: It tends to depress property values and slow price recovery
A large shadow inventory of distressed properties creates downward price pressure because it represents latent supply that will enter the market, competing with traditional sellers.
CMPS Financial and Housing Markets 3
What happens to the price of an existing mortgage-backed security when market interest rates rise?