A pass-through mortgage-backed security:

Question

BlackTom AI · Accepted Answer

Consider the core concept of a pass-through mortgage-backed security and what it does with the cash flows from the underlying pool of mortgages.
Option A: 'Provides investors with a known, fixed maturity date.' This is not generally true for pass-throughs, because the timing of principal repayments depends on the performance of the underlying loans and may be accelerated by prepayments, extending or shortening the expected maturity, so a fixed maturity date is not guaranteed.
Option B: 'Guarantees investors will be protected against prepayment risk.' In fact, pass-throughs expose investors to prepayment risk because borrowers may refinance or pay off their loans earlier than expected, which can alter anticipated cash flows; there is no guarantee against this risk.
Option C: 'Passes all principal and interest payments from the underlying mortgages to investors on a pro rata basis.' This statement aligns with the standard structure of pass-through securities: borrowers’ payments flow through to security holders in proportion to their ownership of the pool, after servicing and administrative fees are deducted. The pro rata distribution of both P&I is the defining feature.
Option D: 'Completely eliminates credit risk for all investors.' This is incorrect because pass-throughs carry credit risk tied to the originating mortgages and the underlying pool; default risk and credit concerns remain, albeit mitigated through diversification and guarantees in some structures, but not eliminated entirely.
In summary, the description in Option C accurately captures the essential mechanism of a pass-through MBS, while the other options describe features that are not characteristic of standard pass-through securities.

A pass-through mortgage-backed security:Single choice

Similar Questions

Interest-Only (IO) strips created from mortgage-backed securities:

A Collateralized Mortgage Obligation (CMO) addresses prepayment risk by:

What is the primary purpose of creating different CMO tranches (Class A, B, C) from a pool of mortgages?

A depository institution holds IO strips as a hedge against its regular bond portfolio. The CFO argues this hedge will be effective, but the risk manager expresses concern. Under what market scenario would the IO hedge fail to provide the expected protection?

Why are Principal Only (PO) strips particularly attractive to investors taking directional bets on interest rate movements?

Why do Interest Only (IO) strips exhibit negative duration characteristics at yields below the mortgage coupon rate?

Why does the R-class (residual class) in a CMO potentially have negative duration, and what makes it valuable despite being called the 'garbage class'?

More Practical Tools for Students Powered by AI Study Helper

Homework AI Solver

Stylized AI Paper Writer

Plagiarism Checker Assistant

Citation AI Academic Writing Tool

In-Class Translation Assistant

AI Note Generator

AI Quiz Answers

Past Exam Questions from University Test Bank

Smart Practice Assistant

Adaptive Practice

Making Your Study Simpler