Veronesi : Basics of RMBS
9 important questions on Veronesi : Basics of RMBS
What is the characteristic of an agency RMBS
It is issued by an government agency. The underlying collateral is guaranteed or insured by one of the three government (government sponsored) entities.
What are the similarities and differences between Freddie Mac, Fannie Mae and Ginnie Mae?
- Only Ginnie Mae is a true goverment ownded agency. The other two are Government Sponsored Agencies (GSAs). Securities guaranteerd by Ginnie Mae are default-free securities. The others are not.
- Ginnie Mae only guarantees timely payment of principal and interest from approved issuers of qualified loans. Something Freddie Mac and Fannie Mae do too.
- In addition, Freddie Mac and Fannie Mae purchase and maintain a large portfolio. It also issues debt to finance its portfolio.
What six factors influence prepayment rates?
- Most important: declining interest rates. If there are no people left that can or want to refinance, this is called a burn out effect.
- housing prices: more prepayments when prices are falling
- seasonality: more prepayments in summer
- age of the mortgage pool:
- specific familiy reasons:
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Three important factors in determining the value of an MBS portfolio are:
- Weighted average maturity
- Weighted average coupon
- Speed of prepayments
What is the PSA prepayment model
- the prepayment rate (CPR) will be 0,2% the first month
- it will increase by o,2% for the first 30 months
- after the 30th month it will peak at 6% and remain constant to maturity
Explain the negative convexity for MBS?
The value of a pool of mortgages increases when interest rates decline (so positive duration), but at a declining rate because increased prepayments.
What is the difference between an MBS and a CMO
CMO is a (more complex) type of an MBS. CMOs have tranches, whereas MBS is simple pass through. This means all investors are entitled to a pro-rate share of all principal and interest payments made on the pool.
Name and describe the two kind of CMO tranche structures
- Sequential Pay Structure: All tranches receive the interest payments, but principal payment is first received only by tranche A. Once A is fully paid, tranche B receives principal, etc. Tranche Z acts like a buffer and is like a zero coupon bond.
- Planned Amortization Class: principal repayment occurs through fixed schedule. Differences in repayments are absorbed the companion tranche.
How does the duration look like of interest only and principal only strips?
Effective duration of interest only is negative
Effective duration of principal only is large and positive: i.e. duration can exceed the average maturity of the pool.
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