CRU Portfolio Management & Strategy 2 — Questions and Answers
Question 1: A lender notices that 35% of its residential mortgage portfolio consists of loans with LTVs above 90%. Which risk management action is most appropriate?
- Immediately sell all high-LTV loans on the secondary market
- Purchase private mortgage insurance or increase capital reserves for those loans (Correct answer)
- Reclassify the loans as commercial to reduce reporting requirements
- Lower interest rates on high-LTV loans to incentivize faster payoff
Correct answer: Purchase private mortgage insurance or increase capital reserves for those loans
High-LTV loans carry elevated default risk, so obtaining PMI or holding additional capital reserves is the standard risk mitigation approach.
Question 2: In portfolio management, what does 'concentration risk' specifically refer to in a residential mortgage context?
- The risk that interest rates will rise faster than loan rates can be adjusted
- Excessive exposure to a single borrower type, geography, or product type (Correct answer)
- The administrative burden of managing a large number of small loans
- Risk arising from mortgage servicer operational failures
Correct answer: Excessive exposure to a single borrower type, geography, or product type
Concentration risk occurs when a portfolio is overexposed to a single segment, such as one geographic area or loan product, amplifying losses if that segment deteriorates.
Question 3: Which portfolio metric best measures the proportion of loans that are 90 or more days delinquent?
- Prepayment speed (CPR)
- Serious delinquency rate (Correct answer)
- Net interest margin
- Debt-service coverage ratio
Correct answer: Serious delinquency rate
The serious delinquency rate tracks loans 90+ days past due, which are most at risk of foreclosure and represent the greatest credit loss exposure.
Question 4: A portfolio manager wants to hedge against prepayment risk in a fixed-rate mortgage portfolio. Which instrument is most commonly used?
- Credit default swaps
- Interest rate caps
- Interest rate swaps or swaptions (Correct answer)
- Currency forwards
Correct answer: Interest rate swaps or swaptions
Interest rate swaps and swaptions help offset the duration uncertainty caused by borrower prepayments in fixed-rate mortgage portfolios.
Question 5: When building a diversified residential mortgage portfolio, an underwriter should prioritize loans from multiple geographic markets primarily to:
- Reduce the cost of loan origination across regions
- Minimize correlation of defaults driven by regional economic shocks (Correct answer)
- Comply with CRA lending requirements in all markets
- Standardize appraisal methodologies across the portfolio
Correct answer: Minimize correlation of defaults driven by regional economic shocks
Geographic diversification reduces the likelihood that a single regional downturn will cause simultaneous losses across the entire portfolio.
Question 6: Which of the following best describes a 'whole loan sale' strategy in portfolio management?
- Selling individual mortgage loans outright to another institution without retaining servicing (Correct answer)
- Securitizing a pool of loans and retaining the residual tranche
- Transferring only the servicing rights while keeping the mortgage on the balance sheet
- Repurchasing previously sold loans to restore portfolio yield
Correct answer: Selling individual mortgage loans outright to another institution without retaining servicing
A whole loan sale transfers full ownership of individual mortgage loans to a buyer, removing them from the seller's balance sheet and eliminating ongoing credit risk.
Question 7: A lender's residential mortgage portfolio has an average coupon of 4.5% while current market rates are 7%. What portfolio risk does this most directly create?
- Elevated credit risk due to rising borrower defaults
- Reduced prepayment speeds and extension risk (Correct answer)
- Increased liquidity risk from margin calls
- Higher operational risk from loan modifications
Correct answer: Reduced prepayment speeds and extension risk
When market rates rise above existing loan rates, borrowers have no incentive to refinance, extending the portfolio's duration beyond expectations — known as extension risk.
CRU Portfolio Management & Strategy 2
A lender notices that 35% of its residential mortgage portfolio consists of loans with LTVs above 90%.
Which risk management action is most appropriate?