CMPS Financial and Housing Markets 4 — Questions and Answers
Question 1: What is 'duration' as it applies to mortgage-backed securities?
- The original maturity term of the underlying mortgages
- A measure of a security's price sensitivity to changes in interest rates (Correct answer)
- The average time until principal is fully repaid under a fixed prepayment assumption
- The length of time a servicer holds payments before remitting to investors
Correct answer: A measure of a security's price sensitivity to changes in interest rates
Duration measures how much a bond or MBS price will change for a given change in interest rates; higher duration means greater price sensitivity.
Question 2: When mortgage rates decline, what typically happens to existing fixed-rate mortgage borrowers and MBS investors respectively?
- Borrowers benefit; investors face prepayment risk as refinancing accelerates (Correct answer)
- Both borrowers and investors benefit equally from lower rates
- Borrowers face higher payments; investors receive higher yields
- Neither is affected since the loan terms are fixed at origination
Correct answer: Borrowers benefit; investors face prepayment risk as refinancing accelerates
Falling rates create a refinancing opportunity for borrowers, which is a benefit to them but a risk for MBS investors who lose their higher-yield income stream.
Question 3: Which of the following best describes 'negative amortization' in a mortgage product?
- A loan where the balance decreases faster than scheduled due to extra payments
- A loan where the minimum payment is less than accruing interest, causing the balance to grow (Correct answer)
- A fixed-rate loan where the interest rate is below the market rate
- A loan product where the principal is forgiven at the end of the term
Correct answer: A loan where the minimum payment is less than accruing interest, causing the balance to grow
Negative amortization occurs when a borrower's payment doesn't cover all accrued interest, so the unpaid interest is added to the principal balance, causing it to increase.
Question 4: What does the 'months of supply' metric in housing markets indicate when it reads 3 months?
- It would take 3 months to build enough new homes to meet demand
- At the current sales pace, all listed homes would sell within 3 months (Correct answer)
- Buyers must wait 3 months on average before finding a home to purchase
- New construction pipelines are 3 months behind schedule
Correct answer: At the current sales pace, all listed homes would sell within 3 months
Months of supply divides current inventory by the monthly sales rate; 3 months means the market is quite tight (seller's market), as 6 months is considered balanced.
Question 5: What is the primary reason mortgage lenders sell loans on the secondary market shortly after origination?
- To avoid credit risk entirely by transferring all loans immediately
- To replenish capital so they can originate additional loans (Correct answer)
- To comply with federal regulations requiring loan transfers within 30 days
- To reduce the administrative burden of servicing mortgage accounts
Correct answer: To replenish capital so they can originate additional loans
Selling loans to secondary market investors returns capital to the lender, enabling them to fund new mortgage originations without being constrained by their balance sheet.
Question 6: How does a high home price-to-income ratio in a given metro area typically affect mortgage lending activity?
- It has no effect because lenders evaluate individual borrowers, not market ratios
- It reduces affordability, tightening the pool of qualified borrowers and often dampening loan volume (Correct answer)
- It increases loan volume because higher-priced homes require larger mortgages
- It exclusively affects jumbo loan originations but not conforming loan activity
Correct answer: It reduces affordability, tightening the pool of qualified borrowers and often dampening loan volume
When home prices greatly exceed local incomes, fewer households can qualify for mortgages at standard debt-to-income thresholds, reducing the overall addressable market for lenders.
Question 7: What market condition describes a period when both home prices and mortgage rates are rising simultaneously?
- A balanced market with neutral affordability trends
- A double-compression environment that severely reduces affordability and can stall transaction volume (Correct answer)
- A seller's market that benefits all homeowners regardless of their financing situation
- A period of healthy economic expansion that increases housing supply
Correct answer: A double-compression environment that severely reduces affordability and can stall transaction volume
When both home prices and interest rates rise together, affordability is compressed from two directions — higher price AND higher monthly payment — which can sharply reduce buyer activity.
CMPS Financial and Housing Markets 4
What is 'duration' as it applies to mortgage-backed securities?