Mortgage-Backed Security (MBS) Instrument and Market Features

How mortgage loans work and why the borrower's right to prepay makes their cash flows uncertain, how residential pass-throughs and CMOs package and reshuffle that prepayment risk, and why commercial MBS behave differently: call protection, balloon risk, concentration risk and the DSC and LTV ratios.

1. 1. Prepayment risk and time tranchingBorrowers can repay principal faster or slower than scheduled as interest rates move, and time tranching splits a pool into bonds with different expected maturities so investors can choose which side of that risk they bear.Video · 6 minFree11 min
2. 2. Residential mortgage loansA mortgage is a loan secured by property, and four features decide how risky it is for whoever ends up holding it: how much equity the borrower has (LTV), how stretched their income is (DTI), whether they can prepay, and whether the lender can chase them beyond the house (recourse).14 min
3. 3. Agency and non-agency RMBS, and pass-throughsA mortgage pass-through hands investors the pool's monthly interest, scheduled principal and prepayments, minus fees, so its coupon sits below the pool's average mortgage rate and its cash flows inherit all the pool's prepayment risk.Video · 7 min13 min
4. 4. Collateralized mortgage obligations (CMOs)A CMO takes the cash flows of mortgage pools and pass-throughs and carves them into tranches with different prepayment exposures, so the risk is not removed but moved to the investors best able to bear it.Video · 7 min15 min
5. 5. Commercial mortgage-backed securities (CMBS)CMBS are backed by a small number of loans on income-producing property, so they have little contraction risk thanks to call protection, but more concentration and balloon (extension) risk, judged with the DSC and LTV ratios.15 min