Question

Please respond to the following:

• Create an argument related to mortgage-back securities (MBS) that either supports or does not support that the benefits outweigh the costs. In what ways is the trading of MBS similar and different from trading of corporate bonds?
• Do you feel there exists sufficient governance over the debt and equity markets to ensure market participants are sufficiently protected? When does buyer beware matter?

Answer 1

The benefits of MBS definitely outweigh the costs associated with MBS. This is because MBS offers a unique set of benefits that are not provided by other financial instruments. First of all MBS have, on a historical basis, a high degree of liquidity, a high Sharpe ratio and a low level of correlation to risk assets. Secondly MBS are complex financial instruments and hence the associated complexities tend to create market dislocations. These dislocations make MBS an attractive alpha-generating instrument.

MBS are traded in secondary markets in a manner that is very similar to trading of corporate bonds and even stocks. The difference between trading in MBS and corporate bonds is that trading in MBS is based on a rate sheet in which lenders set the rates and the corresponding premiums for those rates. Corporate bonds are usually traded OTC (over the counter) and not through exchanges and use of rate sheet is rare.

Yes, I feel that there exists sufficient governance over the debt and equity markets to ensure market participants are sufficiently protected. IN USA regulation and governance exist both at the Federal level as well as the State level. The primary regulator is SEC (Securities and Exchange Commission) and then there are self-regulatory organizations like FINRA (Financial Industry Regulatory Authority). These organizations ensure that the interests of investors and other stakeholders are protected through a robust set of rules, guidelines, regulations and governance.

Buyer beware is a warning that notifies a buyer that the goods being bought by him/her is subject to defects. This warning matter in those cases in which the buyer has to make a reasonable inspection of goods when making a purchase. There are instances where defect is obvious upon reasonable inspection before purchase and it is in these cases that the warnings of buyer beware matters.