Real Estate Finance & Investments, 16e (Brueggeman)
Chapter 20 The Secondary Mortgage Market: CMOs and Derivative Securities
1) One way in which a mortgage pay-through bond (MPTB) is similar to a mortgage-backed
bond (MBB) is that the pay-through bond is a debt obligation of the issuer.
2) The CMO is a considered a marketing innovation as well as a financial innovation, because it
is the first security in the secondary mortgage market to have run a prime-time television ad.
3) A derivative security derives its value from another security, index, or financial claim.
4) Investors retain prepayment risk on MBBs, but issuers incur this risk with MPTBs.
5) A floater is a CMO tranche that has a variable interest rate.
6) The issuer of a mortgage pass-through bond bears all of the prepayment risk of the underlying
mortgages.
7) The CMO investor assumes the prepayment risk of the underlying mortgages, although the
CMO modifies how the risk is allocated.
8) In comparison to mortgage pass-though securities, CMOs attract a broader class of investors
because, by prioritizing cash flows, they can offer more specific maturities.
9) A CMO does not completely eliminate prepayment risk.
10) If a premium is paid on a CMO issue (at the time of issue), yields will increase as
prepayment rates accelerate.
11) From the issuer’s perspective, the use of MBBs and MPTBs should be viewed as a method of
debt financing.
12) Cash flows remaining after all CMO tranches have been paid off are referred to as REMICs.
13) CMO investors only pay taxes on interest income.
14) In CMO terminology, planned amortization classes (PACs) are also known as companion
tranches.
15) CDOs often include “B” notes, mezzanine debt and preferred equity as investments.
16) CDO managers raises capital through the issuance of rated CDO debt and equity to purchase
an undiversified pool of credit instruments.
17) In CDOs both equity and debt holders prefer riskier, higher-yielding collateral to collect
excess spreads.
18) Subprime mortgage-backed securities generally include FHA-insured or VA-guaranteed
mortgages, along with conventional mortgages.
19) What is the primary distinction between mortgage-related securities backed by residential
mortgages and those backed by commercial mortgages?
A) Default is the key risk with residential mortgages; prepayment is the key risk with
commercial mortgages
B) Interest rate risk is the key risk with residential mortgages; prepayment is the key risk with
commercial mortgages
C) Prepayment is the key risk with residential mortgages; default is the key risk with commercial
mortgages
D) Prepayment is the key risk with residential mortgages; interest rate risk is the key risk with
commercial mortgages
20) A mortgage company is issuing a CMO with three tranches, with the principal and coupon
rate given in the table below. When issued, the weighted average coupon on the CMO will be:
Tranche
Principal
Coupon
Rate
A
$
40,000,000
9.25
%
B
30,000,000
10.00
%
Z
30,000,000
11.00
%
A) 9.25%
B) 10.00%
C) 10.08%
D) 11.00%
21) Which of the following statements regarding subprime mortgages is TRUE?
A) Subprime mortgages are not Ginnie Mae guaranteed, so CMO investors are exposed to
default risk
B) Subprime mortgages are not Ginnie Mae guaranteed, so securities backed by subprime
mortgages cannot be issued
C) CMOs backed by subprime mortgages cannot be used as collateral for CDOs
D) Due to diversification, securities backed by subprime loans are of no more risk than those
back by prime loans
22) The main purpose of the Term Asset-Backed Securities Loan Facility (TALF) is to:
A) Buy mortgage backed securities owned by Freddie Mac, Fannie Mae, and Ginnie Mae
B) Issue CDOs and use the proceeds to fund infrastructure projects to stimulate the economy
C) Regulate hedge funds to reduce investments in risky assets
D) Use residential loans as collateral to purchase U.S. Treasuries as a way to reduce interest rates
23) Which of the following statements regarding mortgage pass-through bonds (MPTBs) is
FALSE?
A) MPTBs can be viewed as mortgage-backed bonds with the pass-through of principal and
prepayment features of a mortgage pass-through security
B) Most MPTBs are based on residential mortgage pools and are generally overcollateralized
C) MPTBs represent an undivided equity ownership interest in a mortgage pool
D) All of the above are false.
24) The credit rating of an MPTB depends largely on the:
A) Amount of overcollateralization
B) Degree to which government-related securities constitute the excess collateral
C) Riskiness of the mortgage in the underlying pools
D) All of the above
25) In comparison to other mortgage-backed securities, the unique characteristic of CMOs is
that:
A) CMO issuers do not retain ownership of the underlying mortgage pool
B) CMOs are issued in multiple security classes
C) The CMO mortgage pool is not overcollateralized
D) CMOs are a pay-through in which all amortization and prepayments flow through to investors
26) Which of the following is NOT a CMO security type?
A) A repeat floater
B) A Z tranche
C) An inverse floater
D) An IO tranche
27) For which of the following investments is the exact date of maturity known?
A) CMOs
B) MBBs
C) MPTs
D) MPTBs
28) For which of the following investments does the issuer bear all of the prepayment risk?
A) CMOs
B) MBBs
C) MPTs
D) MPTBs
29) Which of the following investments in NOT a debt obligation of the issuer?
A) CMOs
B) MBBs
C) MPTs
D) MPTBs
30) Which of the following is NOT characteristic of commercial-backed mortgage securities?
A) The underlying mortgage pool represents a variety of different property types (retail,
multifamily, etc.) and a specific geographical area
B) The underlying mortgages have usually been outstanding for several years
C) One of the primary issuers of such securities are insurance companies
D) In general, the underlying mortgage pool for such securities contain fewer mortgages than are
included in residential-backed mortgage pools
31) REMICs were created in order to avoid taxes:
A) Entirely
B) At the investor level
C) At the entity level
D) No taxes can be avoided.
32) Duration is defined as:
A) A measure of the extent to which different investments expose an investor to interest rate risk
B) A measure of the weighted-average time required before all principal and interest is received
on an investment
C) A measure that takes into account both the size of cash flows and the timing of their receipt
D) All of the above
33) The residual position in the CMO offering is considered which kind of position?
A) Primary
B) Equity
C) Interest
D) Debt
34) A calamity call, which allows the issuer to recall all securities for a specified time, can be
used in each of the following situations EXCEPT when:
A) Investors want to cash out their positions
B) Interest rates decline sharply
C) Prepayments decline sharply
D) Reinvestment rates are below what was promised to investors
35) The total interest collected from the pool will be ________ if prepayment accelerates;
therefore, the dollar spread between interest inflow and outflow becomes ________.
A) Lower, smaller
B) Lower, wider
C) Higher, smaller
D) Higher, wider
36) Which of the following is FALSE regarding a planned amortization class (PAC) tranche?
A) It has the greatest degree of cash flow certainty
B) Variable payments are received
C) Payments are received over predetermined period of time
D) Payments are received under a range of prepayment scenarios
37) Convexity is a gauge for which of the following?
A) Profitability
B) Return
C) Sensitivity
D) Duration
38) Which of the following does NOT increase the noncredit risks of CDOs?
A) Collateral management risk
B) Certainty in average life of CDO tranches
C) Higher correlation and liquidity
D) None of the above
39) These items are hybrid securities that contain elements of mortgage-backed bonds and
mortgage pass-throughs:
A) MPTBs
B) CDOs
C) CMOs
D) Tranches
40) Class A investors are sometimes repaid with an accelerated pattern of cash flows and are
sometimes referred to as:
A) Accelerated tranches
B) Quick pay tranches
C) Tranche residuals
D) Fast pay tranches
41) A tranche that has a coupon interest rate that adjusts in the opposite direction to its index is
referred to as:
A) Reverse floater tranche
B) Inverse floater tranche
C) Upside-down floater tranche
D) Backwards floater tranche