Ch. 3, Gov't & Gov't Agency Issues | Day 8 Flashcards
(21 cards)
What is Amortization?
Amortization is the process of gradually paying off a loan through scheduled, periodic payments that cover both interest and principal over time.
What is Ginnie Mae and what makes it unique among mortgage agencies?
Ginnie Mae (GNMA) is a wholly owned U.S. government corporation and the only mortgage agency whose securities are backed by the full faith and credit of the U.S. government.
What type of securities does Ginnie Mae issue, and how do investors get paid?
Ginnie Mae issues pass-through certificates. Investors receive monthly payments consisting of both interest and principal from pools of FHA- or VA-insured mortgages.
What is the primary risk associated with Ginnie Mae investments?
The main risk is early refinancing, which reduces the expected interest income due to faster mortgage prepayments when interest rates fall.
What is Fannie Mae and what distinguishes it from Ginnie Mae?
Fannie Mae (FNMA) is a public, for-profit corporation that buys and securitizes mortgages. Unlike Ginnie Mae, it is not fully backed by the U.S. government, but it has a credit line and favorable tax treatment.
How does Fannie Mae generate returns for investors?
Fannie Mae issues mortgage-backed securities and debentures, paying semiannual interest. The securities are taxable at all levels and are sold in denominations ranging from $5,000 to $1 million.
What is Freddie Mac and how is it similar to Fannie Mae?
Freddie Mac (FHLMC) is a publicly traded company that buys residential mortgages, pools them, and sells them to investors. Like Fannie Mae, it’s in business for profit but not backed by the full faith of the U.S. government.
What happened to Fannie Mae and Freddie Mac in the financial crisis?
Both were placed into receivership by the U.S. government in 2008 due to financial instability during the housing crisis.
What is the Federal Farm Credit System (FFCS), and what does it do?
FFCS is a group of privately owned lenders that provide agricultural financing. It issues farm credit securities not backed by the U.S. government to fund loans for farmers.
Name three FFCS lenders and their functions.
Federal Land Bank: provides mortgage money
Bank of the Cooperatives: provides money for feed and grain
Federal Intermediate Credit Bank: funds equipment and tractors
What is a Collateralized Mortgage Obligation (CMO)?
A CMO is a mortgage-backed security structured in tranches that pay monthly principal and interest. Issued by private companies and agencies like FHLMC/FNMA, CMOs are typically backed by pools of mortgages.
What is the primary risk in CMO investments?
The main risk is early refinance risk, which alters the timing of cash flows due to prepayments.
How are CMOs structured to repay investors?
CMOs repay interest monthly to all tranches, but principal is paid sequentially to one tranche at a time in $1,000 increments until the Z tranche is paid last.
What makes the Z tranche unique and risky?
The Z tranche receives no payments until all other tranches are paid. It is the most volatile due to uncertainty in timing.
How do interest rates affect CMOs?
If rates fall, prepayments increase → CMOs are paid off sooner.
If rates rise, prepayments slow → CMOs are paid off more slowly.
What is a Principal-Only (PO) CMO?
A PO CMO receives only principal payments, sold at a discount. It benefits when interest rates fall and prepayments accelerate.
What is an Interest-Only (IO) CMO?
An IO CMO receives only interest payments from mortgages. It gains value when interest rates rise and prepayments slow, extending the interest stream.
What is a Planned Amortization Class (PAC) CMO?
A PAC CMO provides protection against prepayment and extension risk by using a support class to absorb payment variances and ensure a stable schedule.
What is a Targeted Amortization Class (TAC) CMO?
A TAC CMO offers protection against prepayment risk only. It lacks protection against extension risk if payments come in too slowly.
What is a private-label CMO and how is it different from agency CMOs?
Private-label CMOs are issued by investment banks, not government agencies. Their payments are not guaranteed by the government and rely on issuer creditworthiness.
Why must some investors sign suitability statements before purchasing complex CMOs?
Complex CMOs can be illiquid and risky, so not suitable for all investors. Suitability statements ensure the investor understands these risks.
