CAIA Level 1 - Topic 6 Structured Products Questions and Answers 100% Correct.

Primary economic role of structuring - ANSWER-Structured securities complete the market - structured to meet all different needs & helps investors prepare for all states of the world MBS - ANSWER-Mortgage-backed securities - security secured by pool of mortgages (mortgages are the collateral) RMBS - Agency RMBS - ANSWER-Residential MBS - low credit risk: backed by the US government - has prepayment risk: borrower' s right to repay mortgage early a key risk Contraction risk - ANSWER-Average life decreases when rates fall and prepayments increase Extension risk - ANSWER-Average life extension as rates rise and prepayments fall CMO - ANSWER-Collaterialized Mortgage obligations - pool of mortgages are divided into tranches - collects and sell risk exposure to contraction rick & extension risk Sequential-pay tranches - ANSWER-Tranches retired sequentially - senior tranches receives all principal until paid off - all tranches receive interest - each sequential-pay CMO tranche has a mix of contraction and extension risk Z-tranche or accrual tranche - ANSWER-Receives no payments until sequential-pay tranches serviced PAC CMO structure - ANSWER-- PAC tranches: principal payments guaranteed, if prepayment rates are within prescribed range - support tranche: provides prepayment protection to PAC tranches (like a body guard) TAC - ANSWER-targeted amortization class - like a PAC structure, but with more narrow and complex range of prepayment speeds PO & IO strips - ANSWER-Principal-only and interest-only strips: - PO faces extension risk (rates rise and prepayment falls) - IO faces contraction risk (rates fall and prepayment up) Floating / inverse floater rate tranches - ANSWER-Linked to index such as LIBOR Structural Credit Risk Model - ANSWER-Incorporate characteristics of the borrower: 1) str