Question

1. $200 mils of MBBs will be issued against a $300 mils pool of mortgages, in denominations of $10,000 per share for a period of 10 years. The bonds will carry a coupon @8%, payable annually. The bonds are rated of Aaa or AAA. The market rate of return demanded by investors (who purchase MBBs from underwriters) is 10% per annual. Which of the following statement is TRUE?

1. The market price of the MBB on the date of issuance is $9,358 per share.
2. The market price of the MBB on the date of issuance is $8,771 per share.
3. The market price of the MBB on the date of issuance is $10,000 per share.
4. The overcollaterization ratio is 114%.

2. Which of the following statement about the mortgage pools of Mortgage Pass-Through securities is FALSE?

1. Mortgages of different mortgage interest rate can be pooled together to lower the issuance costs.
2. Mortgages of different mortgage interest rate can be pooled together to minimize the correlation of prepayment risk.
3. Mortgages of different mortgage interest rate cannot be pooled together due to the different level of mortgage payment per period.
4. Mortgages of different mortgage interest rate can be pooled together to minimize the correlation of default risk.

3. A falling rate of market interest would have which of the following impacts on a mortgage pass-through security?

1. Increase prepayments on loans in the pool
2. Decrease prepayments on loans in the pool
3. Decrease the market value of the MPT
4. Both A and C

4. Which of the following statements regarding mortgage-backed bonds (MBBs) is generally TRUE?

(A) The total value of the MBBs issued usually equals the value of the mortgages in the underlying pool

(B) Unlike corporate bonds, MBBs usually are issued with variable coupon rates of interest

(C) Overcollateralization of the mortgage pool assures investors that the income from mortgage will be sufficient to pay the interest on bonds and the principal upon maturity.

(D) All else being equal, the less geographic diversification in the mortgage pool, the higher the investment rating of a MBB.

Answer 1

Answer-

Q )

Given

Future value = FV = $ 10000 per share
Number of years = N = 10 years
Coupon payment = 8 % = 8 % x $10000 = $ 800
Rate of return = Interest rate = I/Y = 10 %

Present value = PV = ?

Present Value = PV = $ 8771 per share

Therefore Option B is correct. The market price of the MBB on the date of issuance is $ 8771 per share.

Q )

The Option C is False is the correct choice.

Mortgages of different mortgage interest rate can be pooled together even if the mortgage payment per period is different.
The other options A, B and D are all correct regarding the Mortgage pass through securities.

Q)

The Option A is correct. A falling rate of market interest would increase prepayments on loans in the pool for a mortgage pass-through security.

The Option B is incorrect as it increases but not decreases prepayments on loans in the pool.
The Option C is incorrect as it increases the market value of MPT .

Q )

The Option C is correct. Overcollateralization of the mortgage pool assures investors that the income from mortgage will be sufficient to pay the interest on bonds and the principal upon maturity.

The other Options are incorrect.
The Option A is incorrect as the total value of the MBBs issued is not equal to the value of the mortgages in the underlying pool.
The Option B is incorrect as the MBBs are not issued with variable coupon rates of interest.
The Otion D is incorrect as  the less the geographic diversification in the mortgage pool, the lower the investment rating of a MBB.