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Chapter 20 - Mortgage-Backed Securities

Chapter 20
Mortgage-Backed Securities
Multiple Choice Questions

1. Which one of the following is defined as bonds which represent a claim on the cash flows
of an underlying pool of mortgages which flow through to bondholders?
A. mortgage bonds
B. mortgage certificates
C. mortgage passthroughs
D. collateralized securities
E. mortgage collaterals

2. Mortgage-backed securities are defined as securities whose investment returns are based on
which one of the following?
A. lease payments from the tenants of financed property
B. interest only on mortgage loans
C. loan refinancings
D. condominium fees
E. pool of mortgages

3. Which one of the following terms is applied to the process of creating mortgage-backed
securities from a pool of mortgages?
A. mortgage aggregation
B. mortgage securitization
C. mortgage bundling
D. mortgage pooling
E. mortgage financing

4. When a borrower pays a fixed monthly amount on his or her home mortgage based on a
fixed rate of interest, he or she has which type of mortgage?
A. prepayment-based
B. open-end
C. fixed-rate
D. variable-rate
E. floating-rate

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5. Which one of the following is the amount of a mortgage loan outstanding?


A. mortgage remainder
B. mortgage face value
C. mortgage par value
D. mortgage principal
E. mortgage accrual

6. Which one of the following terms applies to the process of reducing the mortgage principal
over the life of the mortgage according to a schedule?
A. mortgage amortization
B. mortgage prepayment
C. mortgage elimination
D. mortgage securitization
E. mortgage passthrough

7. Mortgage prepayments are best defined by which one of the following?


A. reducing the mortgage according to a schedule over the life of the mortgage
B. paying a monthly mortgage payment before the regular due date
C. paying off the principal faster than required by the amortization schedule
D. paying a cash deposit when purchasing a property
E. paying each mortgage payment as scheduled

8. Which one of the following is the government agency assigned the responsibility of
promoting liquidity in the home mortgage market?
A. FNMA
B. GNMA
C. FHLMC
D. SPIC
E. FDIC

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Chapter 20 - Mortgage-Backed Securities

9. Which one of the following is the type of mortgage pool that guarantees timely payment of
interest and principal?
A. prepaid
B. refinanced
C. secured
D. fully amortized
E. fully modified

10. Which one of the following is the risk associated with receiving a mortgage bond's
principal payments sooner than anticipated?
A. prepayment risk
B. default risk
C. amortized risk
D. market risk
E. seasoned risk

11. FHLMC and FNMA are government-sponsored enterprises charged with which one of the
following duties?
A. providing home mortgages directly to homeowners
B. purchasing only defaulted mortgages from banking institutions
C. guaranteeing mortgages with the full faith and credit of the U.S. government
D. providing guarantees equal to GNMA's to the home mortgage market
E. promoting liquidity in the home mortgage market

12. What is the probability that a mortgage will be prepaid during a given year called?
A. mortgage reduction rate
B. amortization rate
C. filtration rate
D. prepayment rate
E. postponement rate

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13. Seasoned mortgages are defined as mortgages that are, or have been, which of the
following?
A. prepackaged
B. resold
C. being paid faster than scheduled
D. refinanced
E. over 30 months old

14. Which one of the following statements correctly applies to an unseasoned mortgage?
A. The mortgage is less than 30 months old.
B. The mortgage is still held by the original mortgage company.
C. The mortgage has at least one term or provision that is uncommon to most mortgages.
D. The mortgage has an adjustable interest rate that has not been adjusted to date.
E. The mortgage was obtained by a first-time home owner.

15. Which one of the following is the prepayment rate for a mortgage pool which is dependent
upon the age of the mortgages comprising the pool?
A. unseasoned rate
B. average life rate
C. aged payment rate
D. conditional prepayment rate
E. amortized rate

16. The average time it takes for a mortgage in a pool to be paid off is referred to as which
one of the following?
A. average amortized period
B. seasoned period
C. maturity life
D. average life
E. normal pool life

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Chapter 20 - Mortgage-Backed Securities

17. Which one of the following is the measure of interest rate risk for fixed-income
securities?
A. standard deviation
B. Macaulay duration
C. variance
D. Jensen's alpha
E. beta

18. The _____ duration for mortgage-backed securities is the duration measure that accounts
for how mortgage prepayments are affected by changes in interest rates.
A. mean
B. modified
C. average
D. effective
E. adjusted

19. What are the securities which are created by splitting the cash flows from mortgage pools
according to specific allocation rules called?
A. collateralized mortgage obligations
B. collateralized housing bonds
C. mortgage amortized strips
D. pooled mortgage obligations
E. secured mortgage strips

20. Interest-only strips are securities that do which one of the following?
A. pay interest only at maturity
B. pay only the interest cash flows to investors
C. pay interest over the life of the security and the entire principal at maturity
D. pay interest only when requested by the holder with all remaining amounts paid at maturity
E. pay interest monthly and principal quarterly

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21. Which one of the following is a security that only pays the principal cash flows to
investors?
A. split strip
B. interest-only strip
C. amortized strip
D. principal-only strip
E. final strip

22. What are the securities that are created when a mortgage pool is divided into a number of
tranches called?
A. split strips
B. divided CMOs
C. sequential CMOs
D. indexed mortgage splits
E. tranche pools

23. Which one of the following is a mortgage-backed security that has first priority to
scheduled principal payments?
A. priority strip bond
B. principal strip
C. amortized principal strip
D. protected amortization class bond
E. principal priority tranche

24. A mortgage-backed security that has only a subordinate claim to principal payments is
referred to as which type of bond?
A. subsidiary
B. sequential
C. PAC support
D. secondary
E. subordinate

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Chapter 20 - Mortgage-Backed Securities

25. Which one of the following is the range defined by the upper and lower prepayment
schedules of a
PAC bond?
A. PAC collar
B. PAC range
C. PAC space
D. PAC cup
E. PAC field

26. Which one of the following is defined as the yield to maturity for a mortgage-backed
security computed on an assumed prepayment pattern?
A. payment yield
B. assumed yield
C. current yield
D. cash flow yield
E. amortized yield

27. Which one of the following correctly applies to a mortgage passthrough bond?
A. The primary collateral for the bond is the underlying pool of mortgages.
B. All interest received is immediately passed through while principal payments are held until
the bond matures.
C. Each bond represents one home mortgage.
D. These bonds are created via a process known as mortgage collaring.
E. All of these bonds are guaranteed by the full faith and credit of the U.S. government.

28. You own a mortgage passthrough. Which one of the following statements correctly
describes the payments you will receive on that security?
A. The payments will decrease at a constant rate over the life of the security.
B. The payments will increase at a decreasing rate over the life of the security.
C. The payments will be fixed for the life of the security.
D. The payments will vary depending upon the amount paid on the underlying mortgages
each period.
E. The payments will decrease based on the interest shown on the amortization schedule.

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29. Which one of the following financing terms will provide the lowest monthly payment for
a fixed-rate $175,000 mortgage? (No calculations are required.)
A. 10-year, 5.5 percent
B. 10-year, 6.0 percent
C. 15-year, 5.5 percent
D. 15-year, 6.0 percent
E. 30-year, 5.5 percent

30. Which one of the following set of mortgage terms will cause the borrower to pay the most
interest, assuming the mortgage is paid according to the amortization schedule?
A. 10-year, 6.5 percent
B. 10-year, 7.0 percent
C. 15-year, 7.0 percent
D. 30-year, 6.5 percent
E. 30-year, 7.0 percent

31. You have a 30-year, fixed-rate mortgage with equal monthly payments. The amount of
interest you pay each month will _____ and the amount of principal you pay each month will
____.
A. decrease; decrease
B. decrease; increase
C. increase; decrease
D. increase; increase
E. remain constant; remain constant

32. You have a 15-year, fixed-rate, $150,000 mortgage. The monthly payment amount is
constant and the mortgage is amortized on a monthly basis. How much will the principal
balance be after the 90th payment has been paid?
A. zero
B. < $75,000
C. $75,000
D. > $75,000
E. cannot be determined from the information provided

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33. When can a homeowner prepay on his or her home mortgage?


A. only on prespecified dates
B. only during the last five years of the loan period
C. only if the prepayment pays the mortgage balance in full
D. at any time
E. only if the property securing the mortgage is being sold

34. Borrowers must pay which one of the following if they are to pay off their home
mortgage?
A. remaining principal balance plus any accrued interest
B. present value of all future payments discounted at the current market rate
C. all remaining payments in full
D. remaining principal balance plus one year's interest
E. present value of the remaining principal balance

35. A mortgage prepayment is similar to which one of the following features of a corporate
bond?
A. collateral provision
B. put provision
C. call provision
D. conversion provision
E. protective covenants provision

36. Which one of the following is NOT a reason why mortgage prepayments occur?
A. house securing the mortgage is sold
B. increase in interest rates
C. homeowner's spouse dies
D. homeowner faces job transfer
E. home is refinanced

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37. Mortgage prepayments are generally a(n) ______ to the mortgage borrower and a(n) ____
to the mortgage investor.
A. advantage; advantage
B. advantage; disadvantage
C. disadvantage; advantage
D. disadvantage; disadvantage
E. advantage; neutral event

38. Which one of the following is most apt to create an environment that increases mortgage
prepayments?
A. home mortgage rates remain relatively steady
B. home mortgage rates decline significantly
C. number of homeowner's defaulting on their mortgages rises
D. homeowner's have steady, secure employment at their current jobs
E. number of employees being transferred for employment purposes declines

39. Which one of the following statements correctly relates to reverse mortgages?
A. The loans allow homeowners to build equity in their property.
B. The total costs associated with the loans are relatively low.
C. Borrowers only qualify if they are 65 years of age or older.
D. Homeowner's make monthly payments of principal and interest.
E. No payments are required from the borrower as long as the borrower lives in the mortgaged
property.

40. Which of the following affect the amount of funds available to a homeowner from a
reverse mortgage?
I. current mortgage balance on the home
II. age of homeowner
III. location of the home
IV. appraised value of the home
A. I and IV only
B. II and III only
C. I, II, and IV only
D. I, III, and IV only
E. I, II, III, and IV

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41. Which one of the following is the key function of GNMA?


A. providing direct financing for first-time home buyers only
B. directly refinancing existing home mortgages
C. providing mortgage funds to military personnel only
D. providing direct financing to first-time home buyers, military personnel, and farmers
E. sponsoring the repackaging of mortgages into mortgage-backed securities pools

42. Which one of the following statements correctly relates to GNMA securities?
A. The primary risk associated with GNMAs is default risk.
B. The minimal denomination of a GNMA when issued is $10,000.
C. GNMA mortgages are guaranteed solely by the FHA.
D. GNMAs were originally established as an agency within the Department of Veteran's
Affairs.
E. If you buy a GNMA you are accepting the risk of prepayment.

43. GNMA mortgage pools are based on mortgages issued by which of the following?
I. FHLMC
II. FNMA
III. FHA
IV. FmHA
A. I and II only
B. II and III only
C. III and IV only
D. I, II, and IV only
E. I, II, III, and IV

44. Which one of the following is a government agency?


A. FHLMC
B. Fannie Mae
C. Freddie Mac
D. GNMA
E. FNMA

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45. The greater the prepayment rate for a mortgage pool, the:
A. slower the payments to the holders of the bonds supported by the pool.
B. greater the decline in the bond principal for bonds supported by the pool.
C. longer the age of the mortgages held in the underlying pool.
D. lower the PSA benchmark rate.
E. greater the default risk.

46. After 30 months, what is the 100 PSA benchmark conditional prepayment rate per year?
A. 3 percent
B. 5 percent
C. 6 percent
D. 8 percent
E. 12 percent

47. You acquired a 30-year mortgage two years ago to purchase your current residence. Your
mortgage is classified as which one of the following?
A. seasoned
B. unseasoned
C. conditional
D. complex
E. deferred

48. How much faster will a mortgage pool with a PSA of 150 be prepaid as compared to the
benchmark?
A. 150 times faster
B. 15 times faster
C. 1.5 times faster
D. 1.5 times slower
E. 15 times slower

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49. Generally, the average life of a mortgage is _____ the mortgage's stated maturity.
A. much less than
B. marginally less than
C. equal to
D. marginally greater than
E. significantly greater than

50. How long is the expected average mortgage life of a mortgage held in a 30-year mortgage
pool with a 100 PSA?
A. 14.68 years
B. 18.29 years
C. 21.33 years
D. 23.90 years
E. 25.25 years

51. A mortgage pool was created six years ago. Which one of the following PSA values is
most apt to apply to that pool if market mortgage rates have been declining quite rapidly over
the past five years?
A. 0
B. 50
C. 100
D. 150
E. 200

52. Monthly payments to investors in GNMA mortgage-backed bonds include which of the
following cash flows?
I. mortgage interest
II. fixed principal payment
III. scheduled amortization of mortgage principal
IV. mortgage prepayments
A. II only
B. I and II only
C. I, III, and IV only
D. I, II, and III only
E. I, II, III, and IV

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53. You just purchased a GNMA mortgage-backed security. Which one of the following
should you expect to receive?
A. fixed monthly payments
B. fixed quarterly payments
C. variable monthly payments
D. variable quarterly payments
E. quarterly payments that decrease at a constant rate

54. Which one of the following statements regarding an original issue $25,000 GNMA bond
is correct?
A. The investor will receive $25,000 as a principal payment at maturity.
B. The investor will receive fixed quarterly interest payments.
C. The investor will receive the future value of $25,000 at maturity.
D. The investor will receive payments totaling $25,000 over the life of the bond.
E. The investor should receive more than $25,000 but the amount of each payment is
unknown in advance.

55. Which one of the following is the reason that Macaulay duration is NOT a good measure
of interest rate risk for mortgage bonds?
A. Mortgage bonds are long-term securities while Macaulay duration is a short-term measure.
B. Macaulay duration assumes the debt has a variable rate and most mortgages have a fixed
rate.
C. Macaulay duration requires bond payments to be made semi-annually.
D. Macaulay duration assumes payments are fixed and mortgage bond payments vary.
E. Macaulay duration only applies to zero-coupon bonds.

56. Historically, what has been the relationship between bond prepayment rates and the
market rate of interest?
A. perfectly related
B. directly related
C. inversely related
D. minimally related
E. unrelated

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57. Which one of the following is the preferred method of evaluating interest rate risk on
mortgage bonds?
A. PSA rating
B. modified duration
C. Macaulay duration
D. effective duration
E. postponed duration

58. If the prepayment schedule for a mortgage pool increases to 100 PSA from 50 PSA, the
related interest-only strips will _____ in value and the related principal-only strips will _____
in value.
A. decrease; decrease
B. decrease; increase
C. increase; decrease
D. increase; increase
E. remain constant; remain constant

59. Which of the following affect the value of a PO strip based on a GNMA bond?
I. changes in the PSA schedule
II. prepayment rates
III. time value of money
IV. changes in the default rates for the underlying mortgages
A. I and II only
B. II and III only
C. I, II, and III only
D. I, II, and IV only
E. I, II, III, and IV

60. Which one of the following is correct concerning the total payment amount on a PO
strip?
A. The total payment amount equals the bond's par value.
B. The total payment amount will either equal or exceed the bond's par value.
C. The total payment will vary based on the PSA schedule.
D. The total payment amount will increase if interest rates decline.
E. The total payment amount will vary if the prepayment rate varies.

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61. The total payment amount on an IO strip is:


A. fixed.
B. equal to the interest rate multiplied by the par value multiplied by the PSA rate schedule.
C. equal to the par value multiplied by the interest rate.
D. unknown until all payments have been made.
E. equal to the total interest computed on the bond's amortization schedule.

62. The value of an IO strip will most likely increase when:


A. the PSA schedule rate decreases from 200 to 100.
B. market interest rates remain constant.
C. prepayments increase.
D. mortgage refinancings increase.
E. market interest rates decrease significantly.

63. Which one of the following will maximize the value of an IO strip?
A. prepaying all mortgages in the underlying mortgage pool
B. minimizing the duration of the underlying mortgage pool
C. maximizing the value of the PO strip
D. amortizing the bonds in the underlying pool faster than anticipated
E. creating conditions where no prepayments occur in the underlying mortgage pool

64. A mortgage pool is divided into A, B, C, and Z-tranches based on the textbook example.
The mortgage principal will initially be paid to which one of the tranches?
A. A-tranche
B. B-tranche
C. C-tranche
D. Z-tranche
E. all tranches on a pro-rata basis

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65. A mortgage pool is divided into A, B, C, and Z-tranches based on the textbook example.
Which tranche will have the longest life?
A. A-tranche
B. B-tranche
C. C-tranche
D. Z-tranche
E. All tranches will have equal lives.

66. A mortgage pool is divided into A, B, C, and Z-tranches as discussed in the textbook.
What happens to the initial interest payment for the Z tranche?
A. It is immediately passed through to holders of Z tranche securities.
B. It is accumulated and held until the Z tranche securities mature.
C. It is exchanged for principal from the A tranche.
D. It is exchanged for principal from the B tranche.
E. It is exchanged for principal from the C tranche.

67. Which one of the following statements regarding PAC bonds is correct?
A. The cash flows from a PAC bond are less certain than those from a Z-tranche bond from a
sequential CMO.
B. PAC bondholders receive the residual cash flows from the underlying mortgage pool.
C. PAC bonds are defined by the specific rules which created them.
D. PAC bonds have bounds based on market interest rates.
E. PAC bond cash flows are unaffected by mortgage prepayments.

68. Which one of the following is required for the cash flows on a PAC bond to be
predictable?
A. market interest rates must remain constant
B. market interest rates must steadily decline
C. mortgage prepayments must remain within the PAC collar
D. PAC support bonds must be prepaid in a timely manner
E. mortgage prepayments must exceed the specified PSA schedule

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69. A PAC support bond is most similar to which tranche in a sequential CMO?
A. A
B. B
C. C
D. Z
E. A PAC bond cannot be compared to a sequential CMO.

70. PAC bondholders receive payments of principal based on which one of the following?
A. an amortization schedule
B. PAC collar's lower PSA prepayment schedule
C. PAC collar's upper PSA prepayment schedule
D. receipt of all principal collected on the underlying pool of mortgages until the bond is paid
in full
E. zero principal from the underlying pool of mortgages until after the PAC companion bonds
have been paid in full

71. After month 30, assuming that prepayments remain within the PAC collar, the holders of a
PAC bond will receive which one of the following payments?
A. a fixed principal payment only
B. a fixed interest payment only
C. a fixed principal payment plus a declining interest payment
D. a declining principal payment only
E. a declining principal payment and a declining interest payment

72. How are the cash flows allocated when actual prepayments fall below a PAC collar's
lower bound?
A. The entire cash flow is paid to the non-PAC support bonds until those bonds are paid in
full.
B. The cash flows are divided between PAC and non-PAC bonds on a pro-rata basis.
C. PAC payments are recomputed to a reduced fixed amount.
D. The entire cash flow is paid to the PAC bondholders.
E. The interest income is paid to the non-PAC bondholders with all principal amounts paid to
the PAC bondholders.

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73. Assume that a mortgage pool follows a specified PSA prepayment schedule. Given this,
the cash flow yield on the mortgage pool will do which one of the following?
A. equal the average interest rate of the mortgages contained in the pool
B. equal the anticipated cash flow for the next year divided by the current value of the pool
C. equate the present value of the future cash flows from the pool to the current value of the
pool
D. equate the average interest rate on the mortgages to the current market rate of interest
E. equal the current market rate of interest

74. What is the monthly mortgage payment on a $235,000, 20-year loan if the interest rate is
7.50 percent?
A. $1,034.07
B. $1,468.75
C. $1,576.06
D. $1,893.14
E. $2,622.47

75. You want to borrow $180,000 at 6.25 percent interest. If you assume a 10-year loan, the
monthly payment will be _____ as compared to _____ if you assume a 20-year loan.
A. $1,237.50; $1,103.88
B. $2,207.75; $1,237.50
C. $2,021.04; $1315.67
D. $2,498.18; $1,103.88
E. $2,498.16; $1,533.50

76. You took out a 15-year, $75,000, 7.35 percent loan 8 years ago. What is your current
principal balance, assuming payments are made monthly?
A. $38,588
B. $45,130
C. $54,988
D. $67,351
E. $68,889

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77. Ten years ago, you borrowed $165,000 for 25 years at 7.5 percent interest. What is the
current principal balance, assuming payments are made monthly?
A. $112,200
B. $131,534
C. $138,314
D. $140,362
E. $147,414

78. You are borrowing $240,000 for 30 years at 7.5 percent. Payments will be made monthly.
What is the total amount of interest you will pay if you pay the loan as agreed over the 30
years?
A. $314,640
B. $324,340
C. $346,360
D. $364,120
E. $396,342

79. Four years ago, you borrowed $250,000 for 20 years at 8 percent. Payments are made
monthly. How much interest have you paid thus far?
A. $74,222
B. $75,756
C. $75,909
D. $76,456
E. $77,121

80. You just assumed a 30-year mortgage for $270,000 at 8 percent interest. How much of the
first monthly payment will be applied to the principal balance?
A. $153.14
B. $167.35
C. $172.17
D. $181.16
E. $193.28

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81. You recently assumed a 15-year mortgage for $150,000 at 6.5 percent interest. How much
of the second monthly payment will be applied to the principal balance?
A. $453.02
B. $482.02
C. $685.00
D. $809.82
E. $938.18

82. You have a 20-year mortgage at 7 percent interest. The initial loan amount was $200,000.
By how much did the principal decrease over the first 10 years of the loan? Payments are
made monthly.
A. $61,345
B. $64,580
C. $65,355
D. $66,453
E. $68,618

83. You have a 30-year, $180,000 mortgage. The interest rate is 7.5 percent. What is the
amount of the mortgage prepayment if you pay $1,400 as your first payment?
A. $128.50
B. $130.46
C. $132.65
D. $135.89
E. $141.41

84. You have a 30-year, $175,000 mortgage at 7.5 percent interest. What is the amount of
your mortgage prepayment if you pay $1,500 as your second mortgage payment? Assume
your first payment was the agreed upon amount.
A. $241.93
B. $248.25
C. $265.44
D. $276.37
E. $289.65

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85. You have decided to pay $1,800 a month on your 30-year, $225,000 mortgage. The
interest rate is 7.75 percent. What is your total prepayment amount for year two?
A. $2,208
B. $2,257
C. $3,387
D. $3,979
E. $4,002

86. You are currently borrowing $120,000 to buy a house. The mortgage is for 15 years at 8
percent. How much would you save each month if you could finance this amount at 7.5
percent for the same time period?
A. $34.37
B. $36.27
C. $38.95
D. $40.24
E. $41.34

87. You are assuming a 30-year mortgage for $230,000 at 7.75 percent interest. How much
would you save in interest if you financed this loan at 7.25 percent for 20 years?
A. $159,603
B. $158,504
C. $156,902
D. $154,116
E. $152,686

88. The CPR for a seasoned 200 PSA mortgage is 11.5 percent. What is the single monthly
mortality?
A. 0.9258 percent
B. 0.9664 percent
C. 0.9949 percent
D. 1.0013 percent
E. 1.0129 percent

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89. The CPR for an unseasoned 100 PSA mortgage is 4.5 percent. What is the single monthly
mortality?
A. 0.3557 percent
B. 0.3635 percent
C. 0.3752 percent
D. 0.3830 percent
E. 0.3986 percent

Essay Questions

90. What are the advantages and the disadvantages of a homeowner selecting a 30-year
mortgage rather than a 20-year mortgage?

91. How do CMOs increase the availability of mortgage funds?

92. Explain what a reverse mortgage is, how it works, and who it is intended to help.

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Chapter 20 Mortgage-Backed Securities Answer Key

Multiple Choice Questions

1. Which one of the following is defined as bonds which represent a claim on the cash flows
of an underlying pool of mortgages which flow through to bondholders?
A. mortgage bonds
B. mortgage certificates
C. mortgage passthroughs
D. collateralized securities
E. mortgage collaterals
See Section 20.1

Bloom's: Knowledge
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.1
Topic: Mortgage Passthroughs

2. Mortgage-backed securities are defined as securities whose investment returns are based on
which one of the following?
A. lease payments from the tenants of financed property
B. interest only on mortgage loans
C. loan refinancings
D. condominium fees
E. pool of mortgages
See Section 20.1

Bloom's: Knowledge
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.1
Topic: Mortgage-Backed Securities

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Chapter 20 - Mortgage-Backed Securities

3. Which one of the following terms is applied to the process of creating mortgage-backed
securities from a pool of mortgages?
A. mortgage aggregation
B. mortgage securitization
C. mortgage bundling
D. mortgage pooling
E. mortgage financing
See Section 20.1

Bloom's: Knowledge
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.1
Topic: Mortgage Securitization

4. When a borrower pays a fixed monthly amount on his or her home mortgage based on a
fixed rate of interest, he or she has which type of mortgage?
A. prepayment-based
B. open-end
C. fixed-rate
D. variable-rate
E. floating-rate
See Section 20.2

Bloom's: Knowledge
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Fixed-Rate Mortgage

20-25

Chapter 20 - Mortgage-Backed Securities

5. Which one of the following is the amount of a mortgage loan outstanding?


A. mortgage remainder
B. mortgage face value
C. mortgage par value
D. mortgage principal
E. mortgage accrual
See Section 20.2

Bloom's: Knowledge
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Principal

6. Which one of the following terms applies to the process of reducing the mortgage principal
over the life of the mortgage according to a schedule?
A. mortgage amortization
B. mortgage prepayment
C. mortgage elimination
D. mortgage securitization
E. mortgage passthrough
See Section 20.2

Bloom's: Knowledge
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Amortization

20-26

Chapter 20 - Mortgage-Backed Securities

7. Mortgage prepayments are best defined by which one of the following?


A. reducing the mortgage according to a schedule over the life of the mortgage
B. paying a monthly mortgage payment before the regular due date
C. paying off the principal faster than required by the amortization schedule
D. paying a cash deposit when purchasing a property
E. paying each mortgage payment as scheduled
See Section 20.2

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Prepayments

8. Which one of the following is the government agency assigned the responsibility of
promoting liquidity in the home mortgage market?
A. FNMA
B. GNMA
C. FHLMC
D. SPIC
E. FDIC
See Section 20.3

Bloom's: Knowledge
Learning Objective: 20-02 Government's role in the secondary market for home mortgages.
Level of Difficulty: Core
Section: 20.3
Topic: Gnma

20-27

Chapter 20 - Mortgage-Backed Securities

9. Which one of the following is the type of mortgage pool that guarantees timely payment of
interest and principal?
A. prepaid
B. refinanced
C. secured
D. fully amortized
E. fully modified
See Section 20.3

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.3
Topic: Fully Modified Mortgage Pool

10. Which one of the following is the risk associated with receiving a mortgage bond's
principal payments sooner than anticipated?
A. prepayment risk
B. default risk
C. amortized risk
D. market risk
E. seasoned risk
See Section 20.3

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.3
Topic: Prepayment Risk

20-28

Chapter 20 - Mortgage-Backed Securities

11. FHLMC and FNMA are government-sponsored enterprises charged with which one of the
following duties?
A. providing home mortgages directly to homeowners
B. purchasing only defaulted mortgages from banking institutions
C. guaranteeing mortgages with the full faith and credit of the U.S. government
D. providing guarantees equal to GNMA's to the home mortgage market
E. promoting liquidity in the home mortgage market
See Section 20.3

Bloom's: Knowledge
Learning Objective: 20-02 Government's role in the secondary market for home mortgages.
Level of Difficulty: Core
Section: 20.3
Topic: Fhlmc and Fnma

12. What is the probability that a mortgage will be prepaid during a given year called?
A. mortgage reduction rate
B. amortization rate
C. filtration rate
D. prepayment rate
E. postponement rate
See Section 20.4

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.4
Topic: Prepayment Rate

20-29

Chapter 20 - Mortgage-Backed Securities

13. Seasoned mortgages are defined as mortgages that are, or have been, which of the
following?
A. prepackaged
B. resold
C. being paid faster than scheduled
D. refinanced
E. over 30 months old
See Section 20.4

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.4
Topic: Seasoned Mortgages

14. Which one of the following statements correctly applies to an unseasoned mortgage?
A. The mortgage is less than 30 months old.
B. The mortgage is still held by the original mortgage company.
C. The mortgage has at least one term or provision that is uncommon to most mortgages.
D. The mortgage has an adjustable interest rate that has not been adjusted to date.
E. The mortgage was obtained by a first-time home owner.
See Section 20.4

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.4
Topic: Unseasoned Mortgages

20-30

Chapter 20 - Mortgage-Backed Securities

15. Which one of the following is the prepayment rate for a mortgage pool which is dependent
upon the age of the mortgages comprising the pool?
A. unseasoned rate
B. average life rate
C. aged payment rate
D. conditional prepayment rate
E. amortized rate
See Section 20.4

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.4
Topic: Conditional Prepayment Rate

16. The average time it takes for a mortgage in a pool to be paid off is referred to as which
one of the following?
A. average amortized period
B. seasoned period
C. maturity life
D. average life
E. normal pool life
See Section 20.4

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.4
Topic: Average Life

20-31

Chapter 20 - Mortgage-Backed Securities

17. Which one of the following is the measure of interest rate risk for fixed-income
securities?
A. standard deviation
B. Macaulay duration
C. variance
D. Jensen's alpha
E. beta
See Section 20.5

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.5
Topic: Macaulay Duration

18. The _____ duration for mortgage-backed securities is the duration measure that accounts
for how mortgage prepayments are affected by changes in interest rates.
A. mean
B. modified
C. average
D. effective
E. adjusted
See Section 20.5

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.5
Topic: Effective Duration for Mbs

20-32

Chapter 20 - Mortgage-Backed Securities

19. What are the securities which are created by splitting the cash flows from mortgage pools
according to specific allocation rules called?
A. collateralized mortgage obligations
B. collateralized housing bonds
C. mortgage amortized strips
D. pooled mortgage obligations
E. secured mortgage strips
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: CMOs

20. Interest-only strips are securities that do which one of the following?
A. pay interest only at maturity
B. pay only the interest cash flows to investors
C. pay interest over the life of the security and the entire principal at maturity
D. pay interest only when requested by the holder with all remaining amounts paid at maturity
E. pay interest monthly and principal quarterly
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Interest-Only Strips

20-33

Chapter 20 - Mortgage-Backed Securities

21. Which one of the following is a security that only pays the principal cash flows to
investors?
A. split strip
B. interest-only strip
C. amortized strip
D. principal-only strip
E. final strip
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Principal-Only Strips

22. What are the securities that are created when a mortgage pool is divided into a number of
tranches called?
A. split strips
B. divided CMOs
C. sequential CMOs
D. indexed mortgage splits
E. tranche pools
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Sequential Cmos

20-34

Chapter 20 - Mortgage-Backed Securities

23. Which one of the following is a mortgage-backed security that has first priority to
scheduled principal payments?
A. priority strip bond
B. principal strip
C. amortized principal strip
D. protected amortization class bond
E. principal priority tranche
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Protected Amortization Class Bond

24. A mortgage-backed security that has only a subordinate claim to principal payments is
referred to as which type of bond?
A. subsidiary
B. sequential
C. PAC support
D. secondary
E. subordinate
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Pac Support Bond

20-35

Chapter 20 - Mortgage-Backed Securities

25. Which one of the following is the range defined by the upper and lower prepayment
schedules of a
PAC bond?
A. PAC collar
B. PAC range
C. PAC space
D. PAC cup
E. PAC field
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Pac Collar

26. Which one of the following is defined as the yield to maturity for a mortgage-backed
security computed on an assumed prepayment pattern?
A. payment yield
B. assumed yield
C. current yield
D. cash flow yield
E. amortized yield
See Section 20.7

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.7
Topic: Cash Flow Yield

20-36

Chapter 20 - Mortgage-Backed Securities

27. Which one of the following correctly applies to a mortgage passthrough bond?
A. The primary collateral for the bond is the underlying pool of mortgages.
B. All interest received is immediately passed through while principal payments are held until
the bond matures.
C. Each bond represents one home mortgage.
D. These bonds are created via a process known as mortgage collaring.
E. All of these bonds are guaranteed by the full faith and credit of the U.S. government.
See Section 20.1

Bloom's: Knowledge
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.1
Topic: Passthrough Bond

28. You own a mortgage passthrough. Which one of the following statements correctly
describes the payments you will receive on that security?
A. The payments will decrease at a constant rate over the life of the security.
B. The payments will increase at a decreasing rate over the life of the security.
C. The payments will be fixed for the life of the security.
D. The payments will vary depending upon the amount paid on the underlying mortgages
each period.
E. The payments will decrease based on the interest shown on the amortization schedule.
See Section 20.1

Bloom's: Knowledge
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.1
Topic: Passthrough Bond

20-37

Chapter 20 - Mortgage-Backed Securities

29. Which one of the following financing terms will provide the lowest monthly payment for
a fixed-rate $175,000 mortgage? (No calculations are required.)
A. 10-year, 5.5 percent
B. 10-year, 6.0 percent
C. 15-year, 5.5 percent
D. 15-year, 6.0 percent
E. 30-year, 5.5 percent
See Section 20.2

Bloom's: Comprehension
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Fixed-Rate Mortgage

30. Which one of the following set of mortgage terms will cause the borrower to pay the most
interest, assuming the mortgage is paid according to the amortization schedule?
A. 10-year, 6.5 percent
B. 10-year, 7.0 percent
C. 15-year, 7.0 percent
D. 30-year, 6.5 percent
E. 30-year, 7.0 percent
See Section 20.2

Bloom's: Comprehension
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Fixed-Rate Mortgage

20-38

Chapter 20 - Mortgage-Backed Securities

31. You have a 30-year, fixed-rate mortgage with equal monthly payments. The amount of
interest you pay each month will _____ and the amount of principal you pay each month will
____.
A. decrease; decrease
B. decrease; increase
C. increase; decrease
D. increase; increase
E. remain constant; remain constant
See Section 20.2

Bloom's: Knowledge
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Amortization

32. You have a 15-year, fixed-rate, $150,000 mortgage. The monthly payment amount is
constant and the mortgage is amortized on a monthly basis. How much will the principal
balance be after the 90th payment has been paid?
A. zero
B. < $75,000
C. $75,000
D. > $75,000
E. cannot be determined from the information provided
See Section 20.2

Bloom's: Comprehension
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Amortization

20-39

Chapter 20 - Mortgage-Backed Securities

33. When can a homeowner prepay on his or her home mortgage?


A. only on prespecified dates
B. only during the last five years of the loan period
C. only if the prepayment pays the mortgage balance in full
D. at any time
E. only if the property securing the mortgage is being sold
See Section 20.2

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.2
Topic: Prepayment

34. Borrowers must pay which one of the following if they are to pay off their home
mortgage?
A. remaining principal balance plus any accrued interest
B. present value of all future payments discounted at the current market rate
C. all remaining payments in full
D. remaining principal balance plus one year's interest
E. present value of the remaining principal balance
See Section 20.2

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Payoff

20-40

Chapter 20 - Mortgage-Backed Securities

35. A mortgage prepayment is similar to which one of the following features of a corporate
bond?
A. collateral provision
B. put provision
C. call provision
D. conversion provision
E. protective covenants provision
See Section 20.2

Bloom's: Comprehension
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Prepayments

36. Which one of the following is NOT a reason why mortgage prepayments occur?
A. house securing the mortgage is sold
B. increase in interest rates
C. homeowner's spouse dies
D. homeowner faces job transfer
E. home is refinanced
See Section 20.2

Bloom's: Comprehension
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Prepayments

20-41

Chapter 20 - Mortgage-Backed Securities

37. Mortgage prepayments are generally a(n) ______ to the mortgage borrower and a(n) ____
to the mortgage investor.
A. advantage; advantage
B. advantage; disadvantage
C. disadvantage; advantage
D. disadvantage; disadvantage
E. advantage; neutral event
See Section 20.2

Bloom's: Comprehension
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Prepayments

38. Which one of the following is most apt to create an environment that increases mortgage
prepayments?
A. home mortgage rates remain relatively steady
B. home mortgage rates decline significantly
C. number of homeowner's defaulting on their mortgages rises
D. homeowner's have steady, secure employment at their current jobs
E. number of employees being transferred for employment purposes declines
See Section 20.2

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Prepayments

20-42

Chapter 20 - Mortgage-Backed Securities

39. Which one of the following statements correctly relates to reverse mortgages?
A. The loans allow homeowners to build equity in their property.
B. The total costs associated with the loans are relatively low.
C. Borrowers only qualify if they are 65 years of age or older.
D. Homeowner's make monthly payments of principal and interest.
E. No payments are required from the borrower as long as the borrower lives in the
mortgaged property.
See Section 20.2

Bloom's: Knowledge
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Reverse Mortgage

40. Which of the following affect the amount of funds available to a homeowner from a
reverse mortgage?
I. current mortgage balance on the home
II. age of homeowner
III. location of the home
IV. appraised value of the home
A. I and IV only
B. II and III only
C. I, II, and IV only
D. I, III, and IV only
E. I, II, III, and IV
See Section 20.2

Bloom's: Comprehension
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Reverse Mortgage

20-43

Chapter 20 - Mortgage-Backed Securities

41. Which one of the following is the key function of GNMA?


A. providing direct financing for first-time home buyers only
B. directly refinancing existing home mortgages
C. providing mortgage funds to military personnel only
D. providing direct financing to first-time home buyers, military personnel, and farmers
E. sponsoring the repackaging of mortgages into mortgage-backed securities pools
See Section 20.3

Bloom's: Knowledge
Learning Objective: 20-02 Government's role in the secondary market for home mortgages.
Level of Difficulty: Core
Section: 20.3
Topic: Gnma

42. Which one of the following statements correctly relates to GNMA securities?
A. The primary risk associated with GNMAs is default risk.
B. The minimal denomination of a GNMA when issued is $10,000.
C. GNMA mortgages are guaranteed solely by the FHA.
D. GNMAs were originally established as an agency within the Department of Veteran's
Affairs.
E. If you buy a GNMA you are accepting the risk of prepayment.
See Section 20.3

Bloom's: Knowledge
Learning Objective: 20-02 Government's role in the secondary market for home mortgages.
Level of Difficulty: Core
Section: 20.3
Topic: Gnma

20-44

Chapter 20 - Mortgage-Backed Securities

43. GNMA mortgage pools are based on mortgages issued by which of the following?
I. FHLMC
II. FNMA
III. FHA
IV. FmHA
A. I and II only
B. II and III only
C. III and IV only
D. I, II, and IV only
E. I, II, III, and IV
See Section 20.3

Bloom's: Knowledge
Learning Objective: 20-02 Government's role in the secondary market for home mortgages.
Level of Difficulty: Intermediate
Section: 20.3
Topic: Gnma

44. Which one of the following is a government agency?


A. FHLMC
B. Fannie Mae
C. Freddie Mac
D. GNMA
E. FNMA
See Section 20.3

Bloom's: Knowledge
Learning Objective: 20-02 Government's role in the secondary market for home mortgages.
Level of Difficulty: Core
Section: 20.3
Topic: Gnma

20-45

Chapter 20 - Mortgage-Backed Securities

45. The greater the prepayment rate for a mortgage pool, the:
A. slower the payments to the holders of the bonds supported by the pool.
B. greater the decline in the bond principal for bonds supported by the pool.
C. longer the age of the mortgages held in the underlying pool.
D. lower the PSA benchmark rate.
E. greater the default risk.
See Section 20.4

Bloom's: Comprehension
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Intermediate
Section: 20.4
Topic: Prepayment Rate

46. After 30 months, what is the 100 PSA benchmark conditional prepayment rate per year?
A. 3 percent
B. 5 percent
C. 6 percent
D. 8 percent
E. 12 percent
See Section 20.4

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.4
Topic: Psa Benchmark

20-46

Chapter 20 - Mortgage-Backed Securities

47. You acquired a 30-year mortgage two years ago to purchase your current residence. Your
mortgage is classified as which one of the following?
A. seasoned
B. unseasoned
C. conditional
D. complex
E. deferred
See Section 20.4

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.4
Topic: Seasoned Mortgages

48. How much faster will a mortgage pool with a PSA of 150 be prepaid as compared to the
benchmark?
A. 150 times faster
B. 15 times faster
C. 1.5 times faster
D. 1.5 times slower
E. 15 times slower
See Section 20.4

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.4
Topic: Psa Rates

20-47

Chapter 20 - Mortgage-Backed Securities

49. Generally, the average life of a mortgage is _____ the mortgage's stated maturity.
A. much less than
B. marginally less than
C. equal to
D. marginally greater than
E. significantly greater than
See Section 20.4

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.4
Topic: Average Mortgage Life

50. How long is the expected average mortgage life of a mortgage held in a 30-year mortgage
pool with a 100 PSA?
A. 14.68 years
B. 18.29 years
C. 21.33 years
D. 23.90 years
E. 25.25 years
See Section 20.4

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.4
Topic: Average Mortgage Life

20-48

Chapter 20 - Mortgage-Backed Securities

51. A mortgage pool was created six years ago. Which one of the following PSA values is
most apt to apply to that pool if market mortgage rates have been declining quite rapidly over
the past five years?
A. 0
B. 50
C. 100
D. 150
E. 200
See Section 20.4

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.4
Topic: Psa Values

52. Monthly payments to investors in GNMA mortgage-backed bonds include which of the
following cash flows?
I. mortgage interest
II. fixed principal payment
III. scheduled amortization of mortgage principal
IV. mortgage prepayments
A. II only
B. I and II only
C. I, III, and IV only
D. I, II, and III only
E. I, II, III, and IV
See Section 20.5

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.5
Topic: Gnma Cash Flows

20-49

Chapter 20 - Mortgage-Backed Securities

53. You just purchased a GNMA mortgage-backed security. Which one of the following
should you expect to receive?
A. fixed monthly payments
B. fixed quarterly payments
C. variable monthly payments
D. variable quarterly payments
E. quarterly payments that decrease at a constant rate
See Section 20.5

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.5
Topic: Gnma Cash Flows

54. Which one of the following statements regarding an original issue $25,000 GNMA bond
is correct?
A. The investor will receive $25,000 as a principal payment at maturity.
B. The investor will receive fixed quarterly interest payments.
C. The investor will receive the future value of $25,000 at maturity.
D. The investor will receive payments totaling $25,000 over the life of the bond.
E. The investor should receive more than $25,000 but the amount of each payment is
unknown in advance.
See Section 20.5

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.5
Topic: Gnma

20-50

Chapter 20 - Mortgage-Backed Securities

55. Which one of the following is the reason that Macaulay duration is NOT a good measure
of interest rate risk for mortgage bonds?
A. Mortgage bonds are long-term securities while Macaulay duration is a short-term measure.
B. Macaulay duration assumes the debt has a variable rate and most mortgages have a fixed
rate.
C. Macaulay duration requires bond payments to be made semi-annually.
D. Macaulay duration assumes payments are fixed and mortgage bond payments vary.
E. Macaulay duration only applies to zero-coupon bonds.
See Section 20.5

Bloom's: Comprehension
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.5
Topic: Macaulay Duration

56. Historically, what has been the relationship between bond prepayment rates and the
market rate of interest?
A. perfectly related
B. directly related
C. inversely related
D. minimally related
E. unrelated
See Section 20.5

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.5
Topic: Prepayment Rate

20-51

Chapter 20 - Mortgage-Backed Securities

57. Which one of the following is the preferred method of evaluating interest rate risk on
mortgage bonds?
A. PSA rating
B. modified duration
C. Macaulay duration
D. effective duration
E. postponed duration
See Section 20.5

Bloom's: Knowledge
Learning Objective: 20-03 The impact of mortgage prepayments.
Level of Difficulty: Core
Section: 20.5
Topic: Macaulay Duration

58. If the prepayment schedule for a mortgage pool increases to 100 PSA from 50 PSA, the
related interest-only strips will _____ in value and the related principal-only strips will _____
in value.
A. decrease; decrease
B. decrease; increase
C. increase; decrease
D. increase; increase
E. remain constant; remain constant
See Section 20.6

Bloom's: Comprehension
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Io and Po Strip Values

20-52

Chapter 20 - Mortgage-Backed Securities

59. Which of the following affect the value of a PO strip based on a GNMA bond?
I. changes in the PSA schedule
II. prepayment rates
III. time value of money
IV. changes in the default rates for the underlying mortgages
A. I and II only
B. II and III only
C. I, II, and III only
D. I, II, and IV only
E. I, II, III, and IV
See Section 20.6

Bloom's: Comprehension
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Po Strip Values

60. Which one of the following is correct concerning the total payment amount on a PO
strip?
A. The total payment amount equals the bond's par value.
B. The total payment amount will either equal or exceed the bond's par value.
C. The total payment will vary based on the PSA schedule.
D. The total payment amount will increase if interest rates decline.
E. The total payment amount will vary if the prepayment rate varies.
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Po Strip

20-53

Chapter 20 - Mortgage-Backed Securities

61. The total payment amount on an IO strip is:


A. fixed.
B. equal to the interest rate multiplied by the par value multiplied by the PSA rate schedule.
C. equal to the par value multiplied by the interest rate.
D. unknown until all payments have been made.
E. equal to the total interest computed on the bond's amortization schedule.
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Io Strip

62. The value of an IO strip will most likely increase when:


A. the PSA schedule rate decreases from 200 to 100.
B. market interest rates remain constant.
C. prepayments increase.
D. mortgage refinancings increase.
E. market interest rates decrease significantly.
See Section 20.6

Bloom's: Comprehension
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Io Strip

20-54

Chapter 20 - Mortgage-Backed Securities

63. Which one of the following will maximize the value of an IO strip?
A. prepaying all mortgages in the underlying mortgage pool
B. minimizing the duration of the underlying mortgage pool
C. maximizing the value of the PO strip
D. amortizing the bonds in the underlying pool faster than anticipated
E. creating conditions where no prepayments occur in the underlying mortgage pool
See Section 20.6

Bloom's: Comprehension
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Io Strip

64. A mortgage pool is divided into A, B, C, and Z-tranches based on the textbook example.
The mortgage principal will initially be paid to which one of the tranches?
A. A-tranche
B. B-tranche
C. C-tranche
D. Z-tranche
E. all tranches on a pro-rata basis
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Tranches

20-55

Chapter 20 - Mortgage-Backed Securities

65. A mortgage pool is divided into A, B, C, and Z-tranches based on the textbook example.
Which tranche will have the longest life?
A. A-tranche
B. B-tranche
C. C-tranche
D. Z-tranche
E. All tranches will have equal lives.
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Tranches

66. A mortgage pool is divided into A, B, C, and Z-tranches as discussed in the textbook.
What happens to the initial interest payment for the Z tranche?
A. It is immediately passed through to holders of Z tranche securities.
B. It is accumulated and held until the Z tranche securities mature.
C. It is exchanged for principal from the A tranche.
D. It is exchanged for principal from the B tranche.
E. It is exchanged for principal from the C tranche.
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Tranches

20-56

Chapter 20 - Mortgage-Backed Securities

67. Which one of the following statements regarding PAC bonds is correct?
A. The cash flows from a PAC bond are less certain than those from a Z-tranche bond from a
sequential CMO.
B. PAC bondholders receive the residual cash flows from the underlying mortgage pool.
C. PAC bonds are defined by the specific rules which created them.
D. PAC bonds have bounds based on market interest rates.
E. PAC bond cash flows are unaffected by mortgage prepayments.
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Pac Bonds

68. Which one of the following is required for the cash flows on a PAC bond to be
predictable?
A. market interest rates must remain constant
B. market interest rates must steadily decline
C. mortgage prepayments must remain within the PAC collar
D. PAC support bonds must be prepaid in a timely manner
E. mortgage prepayments must exceed the specified PSA schedule
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Pac Bonds

20-57

Chapter 20 - Mortgage-Backed Securities

69. A PAC support bond is most similar to which tranche in a sequential CMO?
A. A
B. B
C. C
D. Z
E. A PAC bond cannot be compared to a sequential CMO.
See Section 20.4

Bloom's: Comprehension
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.4
Topic: Pac Support Bond

70. PAC bondholders receive payments of principal based on which one of the following?
A. an amortization schedule
B. PAC collar's lower PSA prepayment schedule
C. PAC collar's upper PSA prepayment schedule
D. receipt of all principal collected on the underlying pool of mortgages until the bond is paid
in full
E. zero principal from the underlying pool of mortgages until after the PAC companion bonds
have been paid in full
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Pac Bonds

20-58

Chapter 20 - Mortgage-Backed Securities

71. After month 30, assuming that prepayments remain within the PAC collar, the holders of a
PAC bond will receive which one of the following payments?
A. a fixed principal payment only
B. a fixed interest payment only
C. a fixed principal payment plus a declining interest payment
D. a declining principal payment only
E. a declining principal payment and a declining interest payment
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Pac Bonds

72. How are the cash flows allocated when actual prepayments fall below a PAC collar's
lower bound?
A. The entire cash flow is paid to the non-PAC support bonds until those bonds are paid in
full.
B. The cash flows are divided between PAC and non-PAC bonds on a pro-rata basis.
C. PAC payments are recomputed to a reduced fixed amount.
D. The entire cash flow is paid to the PAC bondholders.
E. The interest income is paid to the non-PAC bondholders with all principal amounts paid to
the PAC bondholders.
See Section 20.6

Bloom's: Knowledge
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: Pac Bonds

20-59

Chapter 20 - Mortgage-Backed Securities

73. Assume that a mortgage pool follows a specified PSA prepayment schedule. Given this,
the cash flow yield on the mortgage pool will do which one of the following?
A. equal the average interest rate of the mortgages contained in the pool
B. equal the anticipated cash flow for the next year divided by the current value of the pool
C. equate the present value of the future cash flows from the pool to the current value of the
pool
D. equate the average interest rate on the mortgages to the current market rate of interest
E. equal the current market rate of interest
See Section 20.7

Bloom's: Comprehension
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.7
Topic: Cash Flow Yield

74. What is the monthly mortgage payment on a $235,000, 20-year loan if the interest rate is
7.50 percent?
A. $1,034.07
B. $1,468.75
C. $1,576.06
D. $1,893.14
E. $2,622.47

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Payment

20-60

Chapter 20 - Mortgage-Backed Securities

75. You want to borrow $180,000 at 6.25 percent interest. If you assume a 10-year loan, the
monthly payment will be _____ as compared to _____ if you assume a 20-year loan.
A. $1,237.50; $1,103.88
B. $2,207.75; $1,237.50
C. $2,021.04; $1315.67
D. $2,498.18; $1,103.88
E. $2,498.16; $1,533.50

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Mortage Payment

20-61

Chapter 20 - Mortgage-Backed Securities

76. You took out a 15-year, $75,000, 7.35 percent loan 8 years ago. What is your current
principal balance, assuming payments are made monthly?
A. $38,588
B. $45,130
C. $54,988
D. $67,351
E. $68,889

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Mortage Balance

20-62

Chapter 20 - Mortgage-Backed Securities

77. Ten years ago, you borrowed $165,000 for 25 years at 7.5 percent interest. What is the
current principal balance, assuming payments are made monthly?
A. $112,200
B. $131,534
C. $138,314
D. $140,362
E. $147,414

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Balance

20-63

Chapter 20 - Mortgage-Backed Securities

78. You are borrowing $240,000 for 30 years at 7.5 percent. Payments will be made monthly.
What is the total amount of interest you will pay if you pay the loan as agreed over the 30
years?
A. $314,640
B. $324,340
C. $346,360
D. $364,120
E. $396,342

Total interest = ($1,678.11 30 12) - $240,000 = $364,120

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Interest

20-64

Chapter 20 - Mortgage-Backed Securities

79. Four years ago, you borrowed $250,000 for 20 years at 8 percent. Payments are made
monthly. How much interest have you paid thus far?
A. $74,222
B. $75,756
C. $75,909
D. $76,456
E. $77,121

Interest paid to date = ($2,091.10 4 12) - ($250,000 - $226,083 ) = $76,456

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Intermediate
Section: 20.2
Topic: Mortgage Interest

20-65

Chapter 20 - Mortgage-Backed Securities

80. You just assumed a 30-year mortgage for $270,000 at 8 percent interest. How much of the
first monthly payment will be applied to the principal balance?
A. $153.14
B. $167.35
C. $172.17
D. $181.16
E. $193.28

Interest included in first payment = $270,000 (.08/12) = $1,800.00


Principal portion of first payment = $1,981.16 - $1,800.00 = $181.16

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Intermediate
Section: 20.2
Topic: Mortgage Amortization

20-66

Chapter 20 - Mortgage-Backed Securities

81. You recently assumed a 15-year mortgage for $150,000 at 6.5 percent interest. How much
of the second monthly payment will be applied to the principal balance?
A. $453.02
B. $482.02
C. $685.00
D. $809.82
E. $938.18

Interest on the first payment = $150,000 (.065/12) = $812.50


Principal on the first payment = $1,306.66 - $812.50 = $494.16
Interest on the second payment = ($150,000 - $494.16) (.065/12) = $809.82

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Intermediate
Section: 20.2
Topic: Mortgage Amortization

20-67

Chapter 20 - Mortgage-Backed Securities

82. You have a 20-year mortgage at 7 percent interest. The initial loan amount was $200,000.
By how much did the principal decrease over the first 10 years of the loan? Payments are
made monthly.
A. $61,345
B. $64,580
C. $65,355
D. $66,453
E. $68,618

Decrease in principal = $200,000 - $133,547 = $66,453

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Intermediate
Section: 20.2
Topic: Mortgage Amortization

20-68

Chapter 20 - Mortgage-Backed Securities

83. You have a 30-year, $180,000 mortgage. The interest rate is 7.5 percent. What is the
amount of the mortgage prepayment if you pay $1,400 as your first payment?
A. $128.50
B. $130.46
C. $132.65
D. $135.89
E. $141.41

Mortgage prepayment = $1,400 - $1,258.59 = $141.41

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Mortgage Prepayments

20-69

Chapter 20 - Mortgage-Backed Securities

84. You have a 30-year, $175,000 mortgage at 7.5 percent interest. What is the amount of
your mortgage prepayment if you pay $1,500 as your second mortgage payment? Assume
your first payment was the agreed upon amount.
A. $241.93
B. $248.25
C. $265.44
D. $276.37
E. $289.65

Mortgage prepayment = $1,500 - $1,223.63 = $276.37

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Mortage Prepayment

20-70

Chapter 20 - Mortgage-Backed Securities

85. You have decided to pay $1,800 a month on your 30-year, $225,000 mortgage. The
interest rate is 7.75 percent. What is your total prepayment amount for year two?
A. $2,208
B. $2,257
C. $3,387
D. $3,979
E. $4,002

Total prepayment for year 2 = ($1,800 - $1,611.93) 12 = $2,257

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Intermediate
Section: 20.2
Topic: Mortgage Prepayments

20-71

Chapter 20 - Mortgage-Backed Securities

86. You are currently borrowing $120,000 to buy a house. The mortgage is for 15 years at 8
percent. How much would you save each month if you could finance this amount at 7.5
percent for the same time period?
A. $34.37
B. $36.27
C. $38.95
D. $40.24
E. $41.34

Difference = $1,146.78 - $1,112.41 = $34.37

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Intermediate
Section: 20.2
Topic: Mortgage Financing

20-72

Chapter 20 - Mortgage-Backed Securities

87. You are assuming a 30-year mortgage for $230,000 at 7.75 percent interest. How much
would you save in interest if you financed this loan at 7.25 percent for 20 years?
A. $159,603
B. $158,504
C. $156,902
D. $154,116
E. $152,686

Total loan interest = ($1,647.75 30 12) - $230,000 = $363,190

Total loan interest = ($1,817.86 20 12) - $230,000 = $206,288


Interest savings = $363,190 - $206,288 = $156,902

Bloom's: Application
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Intermediate
Section: 20.2
Topic: Mortgage Financing

20-73

Chapter 20 - Mortgage-Backed Securities

88. The CPR for a seasoned 200 PSA mortgage is 11.5 percent. What is the single monthly
mortality?
A. 0.9258 percent
B. 0.9664 percent
C. 0.9949 percent
D. 1.0013 percent
E. 1.0129 percent
SMM = 1 - (1 - .115)1/12 = 1.0129 percent

Bloom's: Application
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.4
Topic: Single Monthly Mortality

89. The CPR for an unseasoned 100 PSA mortgage is 4.5 percent. What is the single monthly
mortality?
A. 0.3557 percent
B. 0.3635 percent
C. 0.3752 percent
D. 0.3830 percent
E. 0.3986 percent
SMM = 1 - (1 - .045)1/12 = 0.3830 percent

Bloom's: Application
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.4
Topic: Single Monthly Mortality

Essay Questions

20-74

Chapter 20 - Mortgage-Backed Securities

90. What are the advantages and the disadvantages of a homeowner selecting a 30-year
mortgage rather than a 20-year mortgage?
Answer will vary
Feedback: The primary advantage is the lower required monthly payment. The primary
disadvantages are the higher total interest cost for the loan and the longer period of payments.
However, if the homeowner has sufficient funds, he or she can prepay on the 30-year
mortgage such that the loan is paid off in 20 years. However, if funds are not available to do
that, the homeowner does have the option of paying the lower 30-year payment amount.
Another disadvantage may be that the longer term loan may carry a higher interest rate.

Bloom's: Comprehension
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Fixed Mortgages

91. How do CMOs increase the availability of mortgage funds?


Answer will vary
Feedback: CMOs are packaged mortgages which are combined into a mortgage pool. This
pool distributes its cash flows to IOs, POs, and PACs which allow individuals and institutions
to purchase those investments which meet their investment needs and goals. These
investments increase the amount of money available for financing mortgages and thus provide
liquidity to the mortgage market.

Bloom's: Comprehension
Learning Objective: 20-04 How collateralized mortgage obligations are created and divided.
Level of Difficulty: Core
Section: 20.6
Topic: CMOs

20-75

Chapter 20 - Mortgage-Backed Securities

92. Explain what a reverse mortgage is, how it works, and who it is intended to help.
Answer will vary
Feedback: A reverse mortgage provides money to a homeowner in exchange for increasing the
mortgage amount due on a home. The homeowner receives payments, either as he or she
needs funds or on a regular basis. These payments, plus the accrued interest and costs, become
a lien on the home. The homeowner pays no payments on this mortgage as long as he or she is
residing in the home. The mortgage becomes due and payable only when the homeowner
either moves from the home or passes away. These mortgages are designed to aid an
individual 62 years of age or older by providing liquidity from the equity ownership in the
home.

Bloom's: Comprehension
Learning Objective: 20-01 The workings of a fixed-rate mortgage.
Level of Difficulty: Core
Section: 20.2
Topic: Reverse Mortgage

20-76