Concept: These on-line quiz questions are not specifically linked to AIMs, but are instead based on recent sample questions. The difficulty level is a notch, or two notches, easier than bionicturtle.com's typical AIM-by-AIM question such that the intended difficulty level is nearer to an actual exam question. As these represent "easier than our usual" practice questions, they are well-suited to online simulation.
Questions:
414.1. A 30-year mortgage has an original balance of $160,000 and a fixed rate of 5.0% per annum with typical monthly payments. Which of the following is nearest to the principal reduced by the first month's mortgage payment?
a. Zero
b. $192.25
c. $666.67
d. $858.91
414.2. As Tuckman explains, "Mortgage borrowers have a prepayment option, that is, the option to pay the lender the outstanding principal at any time and be freed of the obligation to make further payments." In this way, prepayment risk is a defining characteristic of mortgages and mortgage-backed securities (MBS). Each of the following is true about prepayment risk and the prepayment option EXCEPT which is not?
a. The prepayment option implies negative convexity (in the price-rate relationship) at low yields
b. The prepayment option does NOT imply negative duration at low yields
c. It is realistic for a prepayment model to assume the conditional prepayment rat (CPR) is a decreasing function of rates; i.e., CPR increases as rates decrease
d. Due to the prepayment option, the duration of a mortgage-backed security (MBS) should be calculated analytically with Macaulay duration; i.e., as the weighted average maturity of mortgages in the pool where weights are present values of bond cash flows as a proportion of bond price
414.3. According to Tuckman, "A prepayment model uses loan characteristics and the economic environment (i.e., interest rates and sometimes housing prices) to predict prepayments. The most common practice identifies four components of prepayments, namely, in order of importance, refinancing, turnover, defaults, and curtailments. These components are typically modeled separately and their parameters estimated or calibrated so as to approximate available historical data." In regard to these four components of prepayment, each of the following is true EXCEPT which is false?
a. Refinancing is often modeled with an incentive function, for example I = [WAC - R] × WALS × A - K, that defines prepayments as a nondecreasing function of the incentive
b. Prepayments due to turnover are for the most part independent of interest rates, but there is an interaction that cannot be ignored: borrowers are less likely to move if they currently enjoy a below-market mortgage rate, a behavior known as the "lock-in effect"
c. Although defaults are never a source of prepayment since the principal is not recovered, mortgage modifications, on the other hand, are a source of prepayment in most cases
d. Curtailments are partial prepayments by a particular borrower. These tend to be most important when loans are older and balances are low. This driver of prepayments is modeled as a function of loan age and can, with only a couple of years remaining to maturity, rise to a CPR of about 5%.
Answers here:
Questions:
414.1. A 30-year mortgage has an original balance of $160,000 and a fixed rate of 5.0% per annum with typical monthly payments. Which of the following is nearest to the principal reduced by the first month's mortgage payment?
a. Zero
b. $192.25
c. $666.67
d. $858.91
414.2. As Tuckman explains, "Mortgage borrowers have a prepayment option, that is, the option to pay the lender the outstanding principal at any time and be freed of the obligation to make further payments." In this way, prepayment risk is a defining characteristic of mortgages and mortgage-backed securities (MBS). Each of the following is true about prepayment risk and the prepayment option EXCEPT which is not?
a. The prepayment option implies negative convexity (in the price-rate relationship) at low yields
b. The prepayment option does NOT imply negative duration at low yields
c. It is realistic for a prepayment model to assume the conditional prepayment rat (CPR) is a decreasing function of rates; i.e., CPR increases as rates decrease
d. Due to the prepayment option, the duration of a mortgage-backed security (MBS) should be calculated analytically with Macaulay duration; i.e., as the weighted average maturity of mortgages in the pool where weights are present values of bond cash flows as a proportion of bond price
414.3. According to Tuckman, "A prepayment model uses loan characteristics and the economic environment (i.e., interest rates and sometimes housing prices) to predict prepayments. The most common practice identifies four components of prepayments, namely, in order of importance, refinancing, turnover, defaults, and curtailments. These components are typically modeled separately and their parameters estimated or calibrated so as to approximate available historical data." In regard to these four components of prepayment, each of the following is true EXCEPT which is false?
a. Refinancing is often modeled with an incentive function, for example I = [WAC - R] × WALS × A - K, that defines prepayments as a nondecreasing function of the incentive
b. Prepayments due to turnover are for the most part independent of interest rates, but there is an interaction that cannot be ignored: borrowers are less likely to move if they currently enjoy a below-market mortgage rate, a behavior known as the "lock-in effect"
c. Although defaults are never a source of prepayment since the principal is not recovered, mortgage modifications, on the other hand, are a source of prepayment in most cases
d. Curtailments are partial prepayments by a particular borrower. These tend to be most important when loans are older and balances are low. This driver of prepayments is modeled as a function of loan age and can, with only a couple of years remaining to maturity, rise to a CPR of about 5%.
Answers here:
