Mortgage-Backed Security Instrument and Market Features

Topic 19: Mortgage-Backed Security (MBS) Instrument and Market Features

Learning Objectives Coverage

LO1: Define prepayment risk and describe time tranching structures in securitizations and their purpose

Core Concept exam-focus

Prepayment risk is the uncertainty about the timing and amount of principal repayments, creating contraction risk (faster prepayments when rates fall, shortening duration and forcing reinvestment at lower rates) and extension risk (slower prepayments when rates rise, lengthening duration and locking investors into below-market yields). This dual risk creates the negative convexity that distinguishes MBS from option-free bonds, as explored in effective duration and convexity analysis. Time tranching through CMO structures (sequential pay, PAC/support) redistributes prepayment risk across different maturity tranches to match varying investor preferences, transforming unpredictable mortgage cash flows into more predictable securities. duration

Formulas & Calculations

• Prepayment Metrics:

  Single Monthly Mortality (SMM) = Prepayment_month / (Beginning Balance - Scheduled Principal)
  
  Conditional Prepayment Rate (CPR) = 1 - (1 - SMM)^12
  
  PSA Speed = (Actual CPR / PSA Benchmark CPR) × 100
  
  PSA Benchmark:
  - Month 1-30: CPR = 0.2% × Month
  - Month 30+: CPR = 6% (constant)
  

• Weighted Average Life (WAL):

  WAL = Σ(Time × Principal Payment) / Total Principal
  
  Impact of prepayments:
  - 100% PSA: WAL ≈ 7-10 years (30-year mortgage)
  - 200% PSA: WAL ≈ 4-6 years
  - 50% PSA: WAL ≈ 12-15 years
  

• Price-Yield Relationship:

  MBS Price Change ≈ -Modified Duration × Yield Change + 0.5 × Convexity × (Yield Change)²
  
  Negative convexity region:
  When rates fall → Prepayments increase → Duration shortens → Price gains limited
  

Practical Examples

• Sequential Pay CMO Structure:

  $100M pool, 4% coupon, structured as:
  
  Tranche A: $50M, 3.75%, Target 5 years
  - Receives all principal first
  - Protected from extension risk
  - High contraction risk
  
  Tranche B: $30M, 3.95%, Target 15 years
  - Receives principal after A paid
  - Moderate prepayment risk
  
  Tranche C: $20M, 4.05%, Target 30 years
  - Last to receive principal
  - Protected from contraction risk
  - High extension risk
  
  Prepayment scenario (200% PSA):
  - Tranche A: Paid off in 3 years
  - Tranche B: Starts receiving year 3
  - Tranche C: Compressed maturity
  

• PAC-Support Structure:

  $500M pool structured as:
  
  PAC Tranches: $350M
  - Protected within 75-300% PSA
  - Scheduled principal payments
  - Stable average life
  
  Support Tranches: $150M
  - Absorb prepayment volatility
  - Average life varies widely
  - Higher yield for risk
  
  Scenario analysis:
  - At 100% PSA: Both perform as expected
  - At 50% PSA: Support extends dramatically
  - At 400% PSA: Support contracts to <2 years
  

DeFi Application defi-application

• Protocol example: Element Finance (now Pendle) with fixed/variable yield tranching
• Implementation: Smart contract-based principal/yield token splits, automated redistribution
• Advantages/Challenges:
  • Advantages: Programmable tranching, transparent rules, instant settlement
  • Challenges: Limited mortgage tokenization, Chainlink oracle requirements, regulatory barriers

LO2: Describe fundamental features of residential mortgage loans that are securitized

Core Concept exam-focus

Residential mortgages are long-term amortizing loans secured by residential property, featuring various structures (fixed/floating rate, term, amortization), credit characteristics (LTV, DTI, FICO), and prepayment options that determine their securitization potential. These mortgage characteristics drive MBS performance, determining prepayment patterns, default risk, and investor returns — understanding these features is essential for valuation, risk assessment, and portfolio construction. The key underwriting components include loan-to-value (LTV) ratios, debt-to-income (DTI) ratios, credit scores (FICO), the distinction between conforming and non-conforming loans, and prepayment penalties and options.

Formulas & Calculations

• Underwriting Metrics:

  LTV Ratio = Loan Amount / Property Value
  
  Combined LTV (CLTV) = (First Mortgage + Second Mortgage) / Property Value
  
  DTI Ratio = Monthly Debt Payments / Monthly Gross Income
  
  Front-end DTI = Housing Payment / Monthly Gross Income
  Back-end DTI = Total Debt Payments / Monthly Gross Income
  

• Mortgage Payment Calculation:

  Monthly Payment = P × [r(1+r)^n] / [(1+r)^n - 1]
  
  Where:
  P = Principal
  r = Monthly rate
  n = Number of months
  

• Conforming Loan Limits (2024):

  Standard limit: $766,550
  High-cost areas: Up to $1,149,825
  
  Jumbo loans: Above conforming limits
  Higher rates: Typically 0.25-0.75% premium
  

• HP 12C Steps (Monthly Payment):

  Calculate payment for $400,000, 30-year, 6% mortgage:
  
  400000 [PV]                 (Loan amount)
  360 [n]                     (30 years × 12)
  6 [ENTER] 12 [÷] [i]       (Monthly rate)
  [PMT]
  Result: $2,398.20           (Monthly payment)
  

Practical Examples

• Prime vs Subprime Characteristics:

  Prime Mortgage:
  - FICO: >740
  - LTV: <80%
  - DTI: <43%
  - Full documentation
  - Rate: 6.5%
  - Default probability: <1%
  
  Subprime Mortgage:
  - FICO: <620
  - LTV: >90%
  - DTI: >50%
  - Limited documentation
  - Rate: 9.5%
  - Default probability: >10%
  

• Prepayment Behavior Patterns:

  Refinancing incentive analysis:
  
  Current mortgage: $300K at 7%
  Market rate: 5%
  
  Monthly savings: $300K × 2% / 12 = $500
  Refinancing cost: $5,000
  Breakeven: 10 months
  
  Prepayment probability: High (>80% CPR)
  

DeFi Application defi-application

• Protocol example: Bacon Protocol tokenizing home equity
• Implementation: NFT mortgages, on-chain payment tracking, automated servicing
• Advantages/Challenges:
  • Advantages: Transparent payment history, fractional ownership, global Uniswap liquidity
  • Challenges: Legal framework, foreclosure processes, property verification

LO3: Describe types and characteristics of residential mortgage-backed securities, including mortgage pass-through securities and collateralized mortgage obligations, and explain the cash flows and risks for each type

Core Concept exam-focus

RMBS transform pools of residential mortgages into tradeable securities, ranging from simple pass-throughs that distribute cash flows pro-rata to complex CMOs that create multiple tranches with different risk-return profiles and cash flow priorities. With RMBS markets exceeding $10 trillion globally, they provide critical housing finance liquidity — understanding different structures enables proper risk assessment, yield analysis, and portfolio optimization across varying interest rate environments. The key structural components include pass-through securities (simple pro-rata distribution), CMO tranches (time and credit tranching), the important agency versus non-agency distinction, and the mechanisms by which prepayment and credit risk are distributed across investors.

Formulas & Calculations

• Pass-Through Cash Flows:

  Monthly Cash Flow = Interest + Scheduled Principal + Prepayments
  
  Interest = Outstanding Balance × Pass-through Rate / 12
  
  Pass-through Rate = WAC - Servicing - Guarantee Fee
  
  Example:
  WAC: 6.5%
  Servicing: 0.25%
  G-fee: 0.25%
  Pass-through: 6.0%
  

• CMO Waterfall Calculation:

  Sequential Pay Distribution:
  1. Pay interest to all tranches
  2. Pay principal to Tranche A until retired
  3. Pay principal to Tranche B until retired
  4. Continue sequentially
  
  PAC Schedule:
  Principal_PAC = Original Schedule (if within collar)
  Principal_Support = Total Principal - Principal_PAC
  

• Z-Tranche Accrual:

  Accrued Interest = Previous Balance × Coupon Rate / 12
  New Balance = Previous Balance + Accrued Interest
  
  After trigger:
  Cash Interest = Current Balance × Coupon Rate / 12
  

• HP 12C Steps (Pass-through Yield):

  Calculate yield on pass-through at 95 price:
  
  95 [CHS] [PV]               (Price paid)
  100 [FV]                     (Par at maturity)
  6 [PMT]                      (6% coupon)
  84 [n]                       (7-year WAL)
  [i] 12 [×]
  Result: 6.8%                 (Annual yield)
  

Practical Examples

• Agency MBS Pass-Through:

  Fannie Mae 30-year 5.5% pool:
  - Original balance: $100M
  - Current factor: 0.85
  - Current balance: $85M
  - WAC: 6.0%
  - WAM: 320 months
  - Pass-through rate: 5.5%
  
  Monthly cash flow (150% PSA):
  - Interest: $85M × 5.5% / 12 = $389,583
  - Scheduled principal: $125,000
  - Prepayments: $425,000
  - Total: $939,583
  

• Complex CMO Structure:

  $1B collateral creating:
  
  PAC I: $300M, 4%, 3-year average life
  PAC II: $200M, 4.5%, 7-year average life
  Support: $300M, 5.5%, volatile average life
  Z-Tranche: $150M, 6%, accretion period
  IO Strip: $50M notional, receives excess interest
  
  Prepayment scenarios:
  - 50% PSA: Support extends to 20 years
  - 100% PSA: All tranches as expected
  - 300% PSA: Support pays off in 2 years
  - 500% PSA: PAC bands broken, become sequential
  

DeFi Application defi-application

• Protocol example: Figure’s Provenance blockchain for mortgage securitization
• Implementation: On-chain loan origination, automated waterfall payments, tokenized tranches via MakerDAO RWA-style vaults
• Advantages/Challenges:
  • Advantages: Real-time reporting, reduced intermediation, programmable compliance
  • Challenges: Scale limitations, legal enforceability, servicer integration

LO4: Describe characteristics and risks of commercial mortgage-backed securities

Core Concept exam-focus

CMBS are securities backed by commercial mortgages on income-producing properties (office, retail, multifamily, hotel, industrial), featuring balloon payments, call protection, and property-specific risks distinct from residential MBS. With CMBS markets providing $600B+ financing for commercial real estate, they carry fundamentally different risk profiles than RMBS — understanding property-level economics, structural protections, and concentration risks is crucial for investment decisions. The key components include balloon payment structures (creating unique extension risk), call protection mechanisms (lockouts, defeasance, yield maintenance), property type diversification, debt service coverage ratios as the primary credit metric, and the distinction between loan-level and structural protection.

Formulas & Calculations

• CMBS Underwriting Metrics:

  Debt Service Coverage (DSC) = Net Operating Income / Debt Service
  
  NOI = Rental Income - Operating Expenses - Reserves
  
  LTV = Loan Amount / Property Value
  
  Debt Yield = NOI / Loan Amount
  

• Balloon Risk Assessment:

  Refinancing LTV = Balloon Amount / Expected Property Value
  
  Refinancing DSC = Expected NOI / Market Debt Service
  
  Extension probability factors:
  - Current LTV > 75%: High risk
  - DSC < 1.25x: Refinancing challenge
  - Property type stress: Retail/office highest
  

• Call Protection Value:

  Yield Maintenance = PV(Remaining Payments) - Principal
  
  Defeasance Cost = Treasury Purchase Price - Loan Balance
  
  Prepayment Premium = Principal × Premium % × Years Remaining
  

• HP 12C Steps (DSC Calculation):

  Property with $10M NOI, $80M loan at 5%:
  
  10 [ENTER]                   (NOI in millions)
  80 [ENTER] 0.05 [×]         (Annual debt service)
  [÷]
  Result: 2.5x                 (DSC ratio)
  
  LTV if property worth $100M:
  80 [ENTER] 100 [÷] 100 [×]
  Result: 80%                  (LTV ratio)
  

Practical Examples

• CMBS Deal Structure:

  $500M commercial mortgages:
  
  Collateral composition:
  - Office: 40% (Manhattan, SF, DC)
  - Retail: 25% (Regional malls)
  - Multifamily: 20% (Garden apartments)
  - Hotel: 10% (Limited service)
  - Industrial: 5% (Warehouses)
  
  Capital structure:
  - AAA: $350M at L+100, 30% subordination
  - AA: $50M at L+150, 20% subordination
  - A: $40M at L+225, 12% subordination
  - BBB: $30M at L+400, 6% subordination
  - BB: $20M at L+700, 2% subordination
  - B: $10M, first loss piece
  
  Structural features:
  - Weighted average DSC: 1.75x
  - Weighted average LTV: 65%
  - Call protection: 2-year lockout, then defeasance
  

• COVID-19 Impact Case:

  Hotel CMBS Performance 2020:
  
  Pre-COVID (2019):
  - Occupancy: 70%
  - DSC: 1.8x
  - Delinquency: <1%
  
  Peak COVID (2020 Q2):
  - Occupancy: 25%
  - DSC: 0.4x
  - Delinquency: 25%
  
  Recovery (2023):
  - Occupancy: 65%
  - DSC: 1.5x
  - Delinquency: 5%
  
  Losses concentrated in BB and below tranches
  

DeFi Application defi-application

• Protocol example: RealT tokenizing commercial properties with automated rent distribution
• Implementation: Property tokens, on-chain rent collection, DAO governance for property decisions
• Advantages/Challenges:
  • Advantages: Fractional ownership, global investment access, transparent cash flows
  • Challenges: Property management complexity, regulatory compliance, limited Aave market liquidity

Core Concepts Summary (80/20 Principle)

Essential Knowledge (20% that matters 80%)

1. Prepayment Risk Components:

   • Contraction: Rates fall → refinancing → fast prepayment
   • Extension: Rates rise → no refinancing → slow prepayment
   • Negative convexity: Price gains limited when rates fall

2. Key MBS Structures:

   • Pass-through: Simple pro-rata distribution
   • Sequential CMO: Tranches paid in order
   • PAC/Support: Stability for PAC, volatility for support
   • Agency vs Non-agency: Government guarantee distinction

3. Critical Metrics:

   • CPR/PSA: Prepayment speed measures
   • WAL: Average life considering prepayments
   • LTV/DTI: Credit quality indicators
   • DSC: Commercial property coverage

4. CMBS Distinctions:

   • Balloon payments create extension risk
   • Call protection limits prepayments
   • Concentration risk from large loans
   • Property-type performance varies greatly

Advanced Considerations

• IO/PO strips: Inverse relationship to rate changes
• Inverse floaters: Leveraged rate exposure
• Credit IOs: Benefit from better credit performance
• Servicing rights: Valuable intangible assets
• Geographic concentration: Regional economic risks

Comprehensive Formula Sheet formula

Prepayment Metrics

1. Speed Conversions:
   SMM = 1 - (1 - CPR)^(1/12)
   CPR = 1 - (1 - SMM)^12
   
   PSA Standard:
   Month 1-30: CPR = 0.2% × Month
   Month 30+: CPR = 6%
   
   100% PSA = 6% CPR after month 30
   200% PSA = 12% CPR after month 30

Mortgage Mathematics

2. Loan Calculations:
   Payment = P × [r(1+r)^n] / [(1+r)^n - 1]
   
   Remaining Balance = P × [(1+r)^n - (1+r)^t] / [(1+r)^n - 1]
   
   Interest Portion = Balance × Rate / 12
   Principal Portion = Payment - Interest

Pass-Through Analytics

3. Cash Flow Components:
   WAC = Σ(Rate × Balance) / Σ(Balance)
   WAM = Σ(Months × Balance) / Σ(Balance)
   
   Pass-through Rate = WAC - Servicing - G-fee
   
   Monthly CF = Interest + Scheduled Principal + Prepayments

CMO Calculations

4. Tranche Analysis:
   WAL = Σ(Time × Principal) / Total Principal
   
   Sequential Principal:
   If Active_Tranche: Receives all principal
   Else: Receives zero principal
   
   PAC Principal:
   If within bands: Scheduled amount
   If outside bands: Becomes sequential

CMBS Metrics

5. Property Analysis:
   DSC = NOI / Debt Service
   LTV = Loan / Property Value
   Debt Yield = NOI / Loan Amount
   
   Balloon Risk:
   Refinancing LTV = Balloon / Future Value
   Extension Risk = f(LTV, DSC, Market)

Risk Measures

6. Duration and Convexity:
   Effective Duration = (P- - P+) / (2 × P × Δy)
   
   Convexity = (P+ + P- - 2P) / (P × Δy²)
   
   Option-Adjusted Spread:
   OAS = Yield - Treasury - Option Cost

Performance Metrics

7. Default and Loss:
   CDR = (Defaults / Balance) × 12
   Loss Severity = 1 - Recovery Rate
   Loss Rate = CDR × Loss Severity
   
8. Vintage Analysis:
   Cumulative Default = Σ(Period Defaults) / Original
   Cumulative Loss = Σ(Period Losses) / Original

HP 12C Calculator Sequences hp12c

Complete MBS Analysis

Scenario: Evaluate 5.5% pass-through at 102 price
WAL: 8 years, Monthly payments

Step 1: Calculate monthly cash flow
100 [ENTER] 0.055 [ENTER] 12 [÷] [×]
Result: 0.458% monthly

Step 2: Approximate yield (using WAL)
102 [CHS] [PV]
100 [FV]
5.5 [ENTER] 12 [÷] [PMT]
96 [n]                       (8 years × 12)
[i] 12 [×]
Result: 5.2% yield

Step 3: Prepayment impact (200% PSA)
8 [ENTER] 2 [÷]             (WAL halves)
Result: 4-year average life

CMBS Coverage Analysis

Scenario: Office building evaluation
NOI: $5M, Loan: $65M at 4.5%, Value: $80M

Step 1: Calculate DSC
5 [ENTER]                    (NOI)
65 [ENTER] 0.045 [×] [÷]   (÷ Debt service)
Result: 1.71x DSC

Step 2: Calculate LTV
65 [ENTER] 80 [÷] 100 [×]
Result: 81.25% LTV

Step 3: Debt yield
5 [ENTER] 65 [÷] 100 [×]
Result: 7.69% debt yield

Assessment: Marginal credit (high LTV)

CMO Tranche Pricing

Scenario: PAC tranche, 4% coupon, 5-year average life
Trading at 5% yield environment

Step 1: Price calculation
4 [PMT]                      (Annual coupon)
100 [FV]                     (Par value)
5 [i]                        (Market yield)
5 [n]                        (Average life)
[PV]
Result: 95.67 price

Step 2: Support tranche (6% coupon, volatile)
6 [PMT] 7 [i] 10 [n] [PV]
Result: 92.89 price (higher risk)

Practice Problems

Basic Level

1. Prepayment Speed: Convert 9% CPR to SMM. What does 150% PSA mean in month 40?

2. Pass-Through Yield: A 6% pass-through trades at 98. Calculate approximate yield assuming 7-year WAL.

3. CMBS DSC: Property has $3MNOIand$40M loan at 5%. Calculate DSC and assess credit quality.

Intermediate Level

4. CMO Structure: Design sequential tranches for $500M pool. How does 200% PSA affect average lives?

5. Negative Convexity: Explain why MBS at 105 price has limited upside if rates fall 100 bps.

6. CMBS Balloon Risk: $100Mballoondue,propertyworth$110M, NOI $7M. Can it refinance at 6% rates?

Advanced Level

7. PAC Band Breaking: PAC protected 75-300% PSA. What happens to cash flows at 400% PSA?

8. IO/PO Strip Hedge: How do IO and PO strips perform in rising vs falling rate environments?

9. CMBS Subordination: Model losses if largest loan (15% of pool) defaults with 40% severity.

Solutions

1. SMM = 0.78%, 150% PSA = 9% CPR
2. Yield ≈ 6.35%
3. DSC = 1.5x (adequate but not strong)
4. A: $200M(3yr),B:$200M (7yr), C: $100M (15yr) at 100% PSA
5. Prepayments accelerate, duration shortens, price gains capped
6. DSC = 1.94x, LTV = 91%, challenging but possible
7. PAC becomes sequential pay, support receives nothing initially
8. IO gains when rates rise, PO gains when rates fall
9. 6% pool loss, BBB and below tranches impaired

DeFi Applications & Real-World Examples

DeFi Mortgage Protocols

1. Figure’s Provenance Blockchain

HELOC Securitization:
- On-chain origination
- Automated payment processing
- Real-time investor reporting
- Smart contract waterfalls

Benefits:
- 90% cost reduction
- T+0 settlement
- Transparent servicing
- Reduced counterparty risk

2. Bacon Protocol

Home Equity Tokens:
- Fractional home ownership
- No monthly payments
- Share appreciation/depreciation
- Exit via buyback or sale

Structure:
- 20% equity stake typical
- 2% origination fee
- Market-based pricing
- DAO governance

3. Centrifuge Tinlake

Real Estate Bridge Loans:
- New Silver origination
- NFT representation
- DROP/TIN tranching
- On-chain payments

Performance:
- $15M+ originated
- 0% defaults to date
- 4-12% yields
- Monthly liquidity windows

Traditional MBS Innovation

Agency MBS Evolution

Uniform MBS (UMBS) Initiative:
- Fannie/Freddie alignment
- Single TBA market
- Enhanced liquidity
- $7 trillion market

Features:
- 55-day payment delay
- Aligned prepayment speeds
- Common securitization platform
- Improved pricing efficiency

Non-QM Resurgence

Post-2008 Recovery:
- $50B+ annual issuance
- Bank statement loans
- DSCR investor loans
- Foreign national programs

Credit Enhancement:
- 10-15% subordination
- Excess spread 3-5%
- Geographic diversification
- No subprime characteristics

CMBS 2.0 Features

Post-Crisis Improvements:
- Enhanced underwriting (1.75x+ DSC)
- Lower leverage (65% LTV average)
- Better reserves
- Stronger covenants

Single Asset Single Borrower (SASB):
- $100B+ market
- Trophy properties
- Institutional sponsors
- Simplified structure

Historical Case Studies

2008 Financial Crisis - MBS Role case-study

Subprime Collapse:
- $1.3 trillion subprime loans
- 50%+ with stated income
- Negative amortization prevalent
- CDO-squared amplification

Losses:
- AAA subprime: 5-10% losses
- AA: 30-50% losses
- BBB: 90%+ losses
- CDO-squared: Near total loss

COVID-19 MBS Response case-study

Forbearance Impact:
- 8% of mortgages in forbearance
- Agency MBS protected
- Non-agency stressed
- CMBS hotel/retail devastated

Government Response:
- Fed MBS purchases: $2.3T
- Mortgage rates: Historic lows
- Refinancing wave: 300%+ PSA
- Spread compression

Common Pitfalls & Exam Tips

Frequent Mistakes

1. Confusing CPR and PSA: PSA is a prepayment pattern, CPR is a speed
2. Ignoring negative convexity: MBS don’t behave like bullets
3. WAL vs final maturity: WAL much shorter due to prepayments
4. Agency guarantee scope: Credit risk only, not prepayment risk
5. CMBS balloon risk: Not captured by WAL calculations
6. Sequential vs pro-rata: CMOs are sequential, pass-throughs pro-rata

Exam Strategy

• Quick identifications:

  • Agency MBS: Government guarantee mentioned
  • CMO: Multiple tranches described
  • CMBS: Commercial properties, balloon payments
  • Prepayment risk: Contraction and extension

• Key calculations to memorize:

  • 100% PSA = 6% CPR after month 30
  • SMM ≈ CPR/12 (approximation)
  • Pass-through rate = WAC - 50 bps typical
  • DSC >1.25x generally acceptable

Time-Saving Techniques

MBS yield approximation:
Yield ≈ Current yield + (100 - Price) / WAL

Quick PSA conversion:
200% PSA = 12% CPR (after seasoning)
50% PSA = 3% CPR

CMBS health check:
DSC >1.5x and LTV <70% = Strong
DSC <1.25x or LTV >80% = Weak

Key Takeaways

Critical Points for Mastery

1. Prepayment risk creates negative convexity in MBS
2. Time tranching redistributes but doesn’t eliminate prepayment risk
3. Agency MBS have credit guarantee but retain prepayment risk
4. CMOs create tailored risk-return profiles from pools
5. PAC tranches gain stability at support tranche expense
6. CMBS balloon payments create unique extension risk
7. Call protection in CMBS reduces but doesn’t eliminate prepayment
8. Geographic and property concentration matter more in CMBS

Quick Assessment Framework

MBS Investment Checklist:
✓ Understand prepayment assumptions
✓ Assess interest rate sensitivity
✓ Check agency vs non-agency
✓ Evaluate tranche position
✓ Consider extension/contraction scenarios
✓ Review geographic concentration
✓ Analyze underlying credit quality

Red Flags:
✗ Stated income loans
✗ Negative amortization
✗ Geographic concentration >30%
✗ IO loans >20% of pool
✗ LTV >80% average
✗ DSC <1.25x (CMBS)
✗ Single property >10% (CMBS)

Cross-References & Additional Resources

Related Finance Topics

• Topic 13: Effective Duration and Convexity (MBS risk measures) duration
• Topic 17: Securitization (foundational mechanics)
• Topic 18: ABS (non-mortgage securitization comparison)
• Topic 10: Interest Rate Risk (duration and immunization)
• Topic 7: OAS (option-adjusted spread analysis)
• Economics: Housing markets, interest rate cycles
• Quantitative Methods: Monte Carlo simulation for MBS

Key Models and Frameworks

• PSA Prepayment Model: Industry standard benchmark
• Option-Adjusted Spread (OAS): Values embedded options
• Monte Carlo Simulation: Paths for rate-dependent cash flows
• Vector Autoregression: Prepayment modeling

Advanced Resources

1. Industry Publications:

   • SIFMA MBS Market Outlook
   • Urban Institute Housing Finance Center
   • MBA Mortgage Finance Forecast
   • FHFA House Price Index

2. Academic Papers:

   • Gabaix et al: “Limits of Arbitrage in MBS”
   • Stanton: “Rational Prepayment and Valuation of MBS”
   • Downing et al: “MBS Prepayment and Default”

3. DeFi Resources:

   • Figure Provenance Documentation
   • Bacon Protocol Whitepaper
   • Centrifuge Real Estate Methodology
   • MakerDAO RWA Vaults

Review Checklist

Essential Mastery Items

• Understand contraction vs extension risk
• Know prepayment metrics (CPR, PSA, SMM)
• Can explain negative convexity
• Understand pass-through mechanics
• Know CMO tranching structures
• Distinguish agency vs non-agency
• Understand CMBS balloon risk
• Can calculate DSC and LTV

Intermediate Proficiency

• Can analyze PAC/support structures
• Understand Z-tranche mechanics
• Know IO/PO strip behavior
• Can assess refinancing incentive
• Understand WAL vs maturity
• Know call protection types
• Can evaluate credit enhancement
• Understand geographic risk

Advanced Application

• Can model prepayment scenarios
• Understand OAS analysis
• Can structure optimal CMOs
• Know burnout effects
• Understand convexity hedging
• Can map DeFi to TradFi MBS
• Know regulatory impacts (QM, QRM)
• Can design risk management strategies

Pre-Exam Checklist

• Memorized PSA standard schedule
• Know CPR/SMM conversions
• Understand sequential vs pro-rata
• Can identify tranche types quickly
• Know agency guarantee coverage
• Understand CMBS vs RMBS differences
• Reviewed negative convexity concept
• Practiced HP 12C calculations for yields