MORTGAGE-BACKED SECURITIES (MBS): TYPES,
STRUCTURES, AND PREPAYMENT RISK UPDATED
ACTUAL QUESTIONS AND CORRECT ANSWERS
Question:
1. ¡ SECTION 1 — MBS FUNDA- MENTALS
Answer:
Question:
2. MBS (Mortgage-Backed Security)
Answer:
A fixed income security collateralized by a pool of mortgage loans. Investors receive periodic payments
derived from borrower principal and interest payments, net of servicing and guaranty fees.
Question:
3. Pass-Through Security
Answer:
The simplest MBS structure. Borrower cash flows (principal + interest) are passed pro-rata to all investors
after deducting a servicing fee. Every holder owns an undivided interest in the pool.
Question:
4. Agency MBS
Answer:
MBS issued or guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae. Carry de facto U.S. government
backing with effectively zero credit risk, but retain prepayment and interest rate risk.
Question:
5. Non-Agency MBS (Private Label)
Answer:
MBS issued by private institutions without government guarantees. Carry credit risk and require credit
enhancement. Market remains depressed post-2008 crisis.
Question:
6. Fannie Mae (FNMA)
Answer:
Federal National Mortgage Association. A GSE under conservatorship that purchases conforming
conventional mortgages and issues MBS.
Question:
7. Freddie Mac (FHLMC)
Answer:
Federal Home Loan Mortgage Corporation. A GSE similar to Fannie Mae; both now issue Uniform
Mortgage-Backed Securities (UMBS) under a common securitization platform.
,Question:
8. Ginnie Mae (GNMA)
Answer:
Government National Mortgage Association. A U.S. government agency (NOT a GSE) that guarantees
MBS backed by FHA, VA, and USDA loans. Carries explicit full-faith-and-credit government guarantee.
Question:
9. UMBS (Uniform Mortgage-Backed Security)
Answer:
A common, fungible MBS issued jointly by Fannie Mae and Freddie Mac since 2019, designed to improve
liquidity and fungibility between the two agencies in the TBA market.
Question:
10. Securitization
Answer:
The process of pooling financial assets (mortgages) and issuing new securities backed by those cash flows.
Allows originators to transfer risk off balance sheet and free up capital for new lending.
Question:
11. Originator
Answer:
The entity (bank or mortgage company) that creates and initially funds the mortgage loan. Often sells the
loan into the secondary market or directly to a GSE.
Question:
12. Servicer
Answer:
The entity responsible for collecting monthly payments from borrowers and remitting them to investors,
managing escrow, and handling delinquencies. Receives a servicing fee (typically 25 bps for agency
MBS).
Question:
13. Servicer Advance
Answer:
When a borrower is delinquent, the servicer is contractually obligated to advance scheduled principal and
interest to investors regardless, creating liquidity risk for the servicer.
Question:
14. WAC (Weighted Average Coupon)
Answer:
The weighted average of the interest rates on underlying mortgage loans in a pool, weighted by
outstanding principal balance. WAC minus the pass-through rate equals the net servicing spread.
Question:
15. WAM (Weighted Average Maturity)
, Answer:
The weighted average number of months until all mortgages in the pool mature, weighted by outstanding
principal. Indicates pool seasoning and remaining life.
Question:
16. WALA (Weighted Average Loan Age)
Answer:
The weighted average number of months since each mortgage loan in the pool was originated. A
complement to WAM indicating how seasoned a pool is.
Question:
17. Pool Factor
Answer:
A decimal expressing the remaining principal balance of an MBS pool as a fraction of original face value.
A pool factor of 0.75 means 75 cents remain on the dollar of original balance.
Question:
18. Conforming Loan
Answer:
A mortgage that meets GSE guidelines for loan limits and underwriting standards. Only conforming loans
can back agency MBS. Loan limits are set annually by FHFA.
Question:
19. CMO (Collateralized Mortgage Obligation)
Answer:
A complex MBS structure that repackages pass-through cash flows into multiple tranches with different
risk and maturity profiles, redistributing prepayment risk among investor classes.
Question:
20. REMIC (Real Estate Mortgage Investment Conduit)
Answer:
The tax structure used to issue CMOs, introduced in 1987. Allows CMO issuers to pass through income
without entity-level taxation. Fannie Mae issued the first REMIC.
Question:
21. Sequential-Pay CMO
Answer:
A CMO structure where all principal payments go first to the shortest tranche (A) until retired, then to the
next tranche. Creates tranches with distinct average lives and prepayment exposures.
Question:
22. PAC Tranche (Planned Amortization Class)
Answer:
A CMO tranche with a predetermined principal payment schedule maintained across a specified range of
prepayment speeds (the PAC band). Provides call and extension protection at the expense of companion
tranches.
STRUCTURES, AND PREPAYMENT RISK UPDATED
ACTUAL QUESTIONS AND CORRECT ANSWERS
Question:
1. ¡ SECTION 1 — MBS FUNDA- MENTALS
Answer:
Question:
2. MBS (Mortgage-Backed Security)
Answer:
A fixed income security collateralized by a pool of mortgage loans. Investors receive periodic payments
derived from borrower principal and interest payments, net of servicing and guaranty fees.
Question:
3. Pass-Through Security
Answer:
The simplest MBS structure. Borrower cash flows (principal + interest) are passed pro-rata to all investors
after deducting a servicing fee. Every holder owns an undivided interest in the pool.
Question:
4. Agency MBS
Answer:
MBS issued or guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae. Carry de facto U.S. government
backing with effectively zero credit risk, but retain prepayment and interest rate risk.
Question:
5. Non-Agency MBS (Private Label)
Answer:
MBS issued by private institutions without government guarantees. Carry credit risk and require credit
enhancement. Market remains depressed post-2008 crisis.
Question:
6. Fannie Mae (FNMA)
Answer:
Federal National Mortgage Association. A GSE under conservatorship that purchases conforming
conventional mortgages and issues MBS.
Question:
7. Freddie Mac (FHLMC)
Answer:
Federal Home Loan Mortgage Corporation. A GSE similar to Fannie Mae; both now issue Uniform
Mortgage-Backed Securities (UMBS) under a common securitization platform.
,Question:
8. Ginnie Mae (GNMA)
Answer:
Government National Mortgage Association. A U.S. government agency (NOT a GSE) that guarantees
MBS backed by FHA, VA, and USDA loans. Carries explicit full-faith-and-credit government guarantee.
Question:
9. UMBS (Uniform Mortgage-Backed Security)
Answer:
A common, fungible MBS issued jointly by Fannie Mae and Freddie Mac since 2019, designed to improve
liquidity and fungibility between the two agencies in the TBA market.
Question:
10. Securitization
Answer:
The process of pooling financial assets (mortgages) and issuing new securities backed by those cash flows.
Allows originators to transfer risk off balance sheet and free up capital for new lending.
Question:
11. Originator
Answer:
The entity (bank or mortgage company) that creates and initially funds the mortgage loan. Often sells the
loan into the secondary market or directly to a GSE.
Question:
12. Servicer
Answer:
The entity responsible for collecting monthly payments from borrowers and remitting them to investors,
managing escrow, and handling delinquencies. Receives a servicing fee (typically 25 bps for agency
MBS).
Question:
13. Servicer Advance
Answer:
When a borrower is delinquent, the servicer is contractually obligated to advance scheduled principal and
interest to investors regardless, creating liquidity risk for the servicer.
Question:
14. WAC (Weighted Average Coupon)
Answer:
The weighted average of the interest rates on underlying mortgage loans in a pool, weighted by
outstanding principal balance. WAC minus the pass-through rate equals the net servicing spread.
Question:
15. WAM (Weighted Average Maturity)
, Answer:
The weighted average number of months until all mortgages in the pool mature, weighted by outstanding
principal. Indicates pool seasoning and remaining life.
Question:
16. WALA (Weighted Average Loan Age)
Answer:
The weighted average number of months since each mortgage loan in the pool was originated. A
complement to WAM indicating how seasoned a pool is.
Question:
17. Pool Factor
Answer:
A decimal expressing the remaining principal balance of an MBS pool as a fraction of original face value.
A pool factor of 0.75 means 75 cents remain on the dollar of original balance.
Question:
18. Conforming Loan
Answer:
A mortgage that meets GSE guidelines for loan limits and underwriting standards. Only conforming loans
can back agency MBS. Loan limits are set annually by FHFA.
Question:
19. CMO (Collateralized Mortgage Obligation)
Answer:
A complex MBS structure that repackages pass-through cash flows into multiple tranches with different
risk and maturity profiles, redistributing prepayment risk among investor classes.
Question:
20. REMIC (Real Estate Mortgage Investment Conduit)
Answer:
The tax structure used to issue CMOs, introduced in 1987. Allows CMO issuers to pass through income
without entity-level taxation. Fannie Mae issued the first REMIC.
Question:
21. Sequential-Pay CMO
Answer:
A CMO structure where all principal payments go first to the shortest tranche (A) until retired, then to the
next tranche. Creates tranches with distinct average lives and prepayment exposures.
Question:
22. PAC Tranche (Planned Amortization Class)
Answer:
A CMO tranche with a predetermined principal payment schedule maintained across a specified range of
prepayment speeds (the PAC band). Provides call and extension protection at the expense of companion
tranches.
