Introduction to ABS

11. Fran Martin obtains a non-recourse mortgage loan for $500,000. One year later, when the outstanding balance of the mortgage is $490,000, Martin cannot make his mortgage payments and defaults on the loan. The lender forecloses on the loan and sells the house for $315,000. What amount is the lender entitled to claim from Martin? A. $0. B. $175,000. C. $185,000.

A. $0.

21. Which commercial mortgage-backed security (CMBS) characteristic causes a CMBS to trade more like a corporate bond than a residential mortgage-backed security (RMBS)? A. Call protection B. Internal credit enhancement C. Debt-service coverage ratio level

A. Call protection: call protection and prepayment penalty points protect against prepayment risk.

The variability in the average life of the PAC tranche of a CMO relative to the average life of the mortgage pass-through securities from which the CMO is created is: A. Lower B. the same. C. higher

A. Lower: The purpose of creating different bond classes in a CMO is to provide a risk-return profile that is more suitable to investors than the risk-return profile of the mortgage pass-through securities from which the CMO is created.

26. Which of the following best describes the cash flow that owners of credit card receivable asset-backed securities receive during the lockout period? A. No cash flow B. Only principal payments collected C. Only finance charges collected and fees

A. No cash flow

9. Which of the following characteristics of a residential mortgage loan would best protect the lender from a strategic default by the borrower? A. Recourse B. A prepayment option C. Interest-only payments

A. Recourse

12. Which of the following describes a typical feature of a non-agency residential mortgage-backed security (RMBS)? A. Senior/subordinated structure B. A pool of conforming mortgages as collateral C. A guarantee by a government-sponsored enterprise

A. Senior/subordinated structure

22. A commercial mortgage-backed security (CMBS) does not meet the debt-to-service coverage at the loan level necessary to achieve a desired credit rating. Which of the following features would most likely improve the credit rating of the CMBS? A. Subordination B. Call protection C. Balloon payments

A. Subordination

20. Credit risk is an important consideration for commercial mortgage-backed securities (CMBS) if the CMBS are backed by mortgage loans that: A. are non-recourse. B. have call protection. C. haveprepayment penalty points

A. are non-recourse.

25. An excess spread account incorporated into a securitization is designed to limit: A. credit risk. B. extension risk. C. contraction risk.

A. credit risk.

6. In a securitization, time tranching provides investors with the ability to choose between: A. extension and contraction risks. B. senior and subordinated bond classes. C. fully amortizing and partially amortizing loans.

A. extension and contraction risks.

4. In a securitization, the special purpose entity (SPE) is responsible for the: A. issuance of the asset-backed securities. B. collection of payments from the borrowers. C. recovery of underlying assets from delinquent borrowers.

A. issuance of the asset-backed securities.

16. The tranches in a collateralized mortgage obligation (CMO) that are most likely to provide protection against both extension and contraction risk are: A. planned amortization class (PAC) tranches. B. support tranches. C. sequential-pay tranches.

A. planned amortization class (PAC) tranches.

24. Which of the following investments is least subject to prepayment risk? A. Auto loan receivable-backed securities B. Commercial mortgage-backed securities (CMBSs) C. Non-agency residential mortgage-backed securities (RMBSs)

B. Commercial mortgage-backed securities (CMBSs): A critical feature that differentiates CMBSs from RMBSs is the call protection provided to investors. An investor in a RMBS is exposed to considerable prepayment risk because the borrower has the right to prepay the loan before maturity. CMBSs provide investors with considerable call protection that comes either at the structure level or at the loan level.

A risk that investors typically face when holding CMBS (commercial mortgage backed security) is: A. call risk B. balloon risk: many CMS require balloon payments C. contraction risk.

B. balloon risk: many CMS require balloon payments

18. In the context of mortgage-backed securities, a conditional prepayment rate (CPR) of 8% means that approximately 8% of the outstanding mortgage pool balance at the beginning of the year is expected to be prepaid: A. in the current month. B. by the end of the year. C. over the life of the mortgages.

B. by the end of the year.

The monthly cash flows of a mortgage pass-through security most likely: A. are constant. B. change when interest rates decline. C. are equal to the cash flows of the underlying pool of mortgages.

B. change when interest rates decline.

8. If a mortgage borrower makes prepayments without penalty to take advantage of falling interest rates, the lender will most likely experience: A. extension risk. B. contraction risk. C. yield maintenance

B. contraction risk.

27. Collateralized mortgage obligations (CMOs) are designed to: A. eliminate contraction risk in support tranches. B. distribute prepayment risk to various tranches. C. eliminate extension risk in planned amortization tranches.

B. distribute prepayment risk to various tranches.

13. If interest rates increase, an investor who owns a mortgage pass-through security is most likely affected by: A. credit risk. B. extension risk.: C. contraction risk.

B. extension risk.

1. Securitization is beneficial for banks because it: A. repackages bank loans into simpler structures. B. increases the funds available for banks to lend. C. allows banks to maintain ownership of their securitized assets.

B. increases the funds available for banks to lend.

10. William Marolf obtains a 5 million EUR mortgage loan from Bank Nederlandse. A year later the principal on the loan is 4 million EUR and Marolf defaults on the loan. Bank Nederlandse forecloses, sells the property for 2.5 million EUR, and is entitled to collect the 1.5 million EUR shortfall, from Marolf. Marolf most likely had a: A. bullet loan. B. recourse loan. C. non-recourse loan.

B. recourse loan

An additional risk of an investment in an arbitrage collateralized debt obligation relative to an investment in an asset-backed security is: A. the default risk on the collateral assets. B. the risk that the CDO manager fails to earn a return sufficient to pay off the investors in the senior and the mezzanine tranches. C. the risk due to the mismatch between the collateral making fixed-rate payments and the bond classes making floating-rate payments.

B. the risk that the CDO manager fails to earn a return sufficient to pay off the investors in the senior and the mezzanine tranches.

The investment that is most suitable for an investor who is willing and able to accept significant prepayment risk is: A. a mortgage pass-through security. B. the support tranche of a collateralized mortgage obligation. C. the inverse floating-rate tranche of a collateralized mortgage obligation

B. the support tranche of a collateralized mortgage obligation.

23. If a default occurs in a non-recourse commercial mortgage-backed security (CMBS), the lender will most likely: A. recover prepayment penalty points paid by the borrower to offset losses. B. use only the proceeds received from the sale of the property to recover losses. C. initiate a claim against the borrower for any shortfall resulting from the sale of the property.

B. use only the proceeds received from the sale of the property to recover losses.

19. For a mortgage pass-through security, which of the following risks most likely increases as interest rates decline? A. Balloon B. Extension C. Contraction

C. Contraction

2. Securitization benefits financial markets by: A. increasing the role of intermediaries. B. establishing a barrier between investors and originating borrowers. C. allowing investors to tailor credit risk and interest rate risk exposures to meet their individual needs.

C. allowing investors to tailor credit risk and interest rate risk exposures to meet their individual needs.

7. The last payment in a partially amortizing residential mortgage loan is best referred to as a: A. waterfall. B. principal repayment. C. balloon payment.

C. balloon payment.

15. The longest-term tranche of a sequential-pay CMO is most likely to have the lowest: A. average life. B. extension risk. C. contraction risk

C. contraction risk: protection against this risk offered by the other tranches. The longest-term tranche is likely to have the highest average life and extension risk because it is the last tranche repaid in a sequential-pay tranche.

3. A benefit of securitization is the: A. reduction in disintermediation. B. simplification of debt obligations. C. creation of tradable securities with greater liquidity than the original loans.

C. creation of tradable securities with greater liquidity than the original loans.

Defeasance can be best described as: A. a predetermined penalty that a borrower who wants to refinance must pay to do so. B. a contractual agreement that prohibits any prepayments during a specified period of time. C. funds that the borrower must provide to replicate the cash flows that would exist in the absence of prepayments.

C. funds that the borrower must provide to replicate the cash flows that would exist in the absence of prepayments.

14. Which of the following is most likely an advantage of collateralized mortgage obligations (CMOs)? CMOs can A. eliminate prepayment risk. B. be created directly from a pool of mortgage loans. C. meet the asset/liability requirements of institutional investors.

C. meet the asset/liability requirements of institutional investors.

All else being equal, when interest rates decline: A. investors in mortgage pass-through securities face extension risk. B. the weighted average maturity of a mortgage pass-through security lengthens. C. the decrease in the price of a mortgage pass-through security is greater than the decrease in the price of an otherwise identical bond with no prepayment option: refinance can lead to contraction risk

C. the decrease in the price of a mortgage pass-through security is greater than the decrease in the price of an otherwise identical bond with no prepayment option: refinance can lead to contraction risk

The credit risk of a commercial mortgage-backed security is lower: A. the lower the DSC ratio and the lower the LTV. B. the lower the DSC ratio and the higher the LTV. C. the higher the DSC ratio and the lower the LTV.

C. the higher the DSC ratio and the lower the LTV.

17. Support tranches are most appropriate for investors who are: A. concerned about their exposure to extension risk. B. concerned about their exposure to concentration risk. C. willing to accept prepayment risk in exchange for higher returns

C. willing to accept prepayment risk in exchange for higher returns

Loan Level prepayment Protection and structural level prepayment protection.

This CMBS offers investors prepayment protection at both the structure and loan levels. The structural call protection is achieved thanks to the sequential-pay tranches. At the loan level, the CMBS includes three of the four types of call protection—namely, a prepayment lockout, a yield maintenance charge, and defeasance.