Chapter 24
MORTGAGE-BACKED
SECURITIES MARKET
Mortgage-Backed
Securities
Mortgage Pass-Through Securities
Derivative Mortgage-Backed Securities
Collateralized Mortgage Obligations
Stripped Mortgage-Backed Securities
Asset Securitization
Originate mortgage
Sell mortgage to investment banking firm
Insure pool of mortgages
Sell right to service loans
Sell securities collateralized by mortgages
to investors
Foundations of the
Mortgage Market
Federal Home Loan Banks (FHLBs)
Federal Housing Administration (FHA)
Federal National Mortgage Association
(FNMA)
Fannie Mae
Ginnie Mae
Mortgage Pass-Through
Securities
Created when one or more holders of
mortgages form a pool of mortgages and
sell shares in the pool.
Features
more liquid
securitized
Cash Flow Characteristics
Monthly mortgage payments
interest
principal repayment
Timing of monthly mortgage payments and
payments made to investors is not identical
Magnitude of monthly mortgage payments is
greater than payments for pass-through
securities
servicing fee
other fees
Issuers of Mortgage PassThrough Securities
Government National Mortgage
Association
Federal Home Loan Mortgage Corporation
Federal National Mortgage Association
Nonagency Pass-Through
Securities
Conforming mortgages
Nonconforming mortgages
Jumbo loans
Nonagency pass-throughs
Issuers of Nonagency
Pass-Throughs
Commercial Banks
Investment Banking Firms
Others
Credit Enhancements
Corporate Guarantees
Pool insurance from a mortgage insurance
company
Bank letter of credit
Senior/subordinated interests
Prepayment Risk and
Prepayment Conventions
Prepayment risk is the risk associated with
prepayments
Contraction risk
Extension risk
Prepayment Conventions
Prepayment speed
Conditional prepayment rates
Single-monthly mortality rate
Average Life
It is the average time to receipts of
principal payments weighted by the
amount of principal expected.
The average life of a pass-through
depends on the PSA prepayment
assumption.
t  Principal received at time t
Average life  
12 (Total principal)
t 1
T
Collateralized Mortgage
Obligations
Tranches
Collateralized Mortgage Obligations
Types of Tranches
Sequential-Pay CMOs
Accrual Bonds
Planned Amortization Class Tranches
Floating-Rate Tranche
Inverse Floating-Rate Tranche
Stripped Mortgage-Backed
Securities
Created by distributing principal and interest
from pool of underlying mortgages on a pro rata
basis to security holders.
Features
Derivative mortgage security
Hedges prepayment risk
Types:
Partially stripped securities
Interest-only/principal-only securities
Yields on MortgageBacked Securities
Yields are a function of prepayment risk
Yield calculation requires
determination of cash flow
projections of prepayment
The PSA convention is used