Question: Mortgage passthrough certificates and collateralized mortgage obligations (CMOs) are similar in many respects. However, these securities differ in several important aspects.
Which of the following best describes the most important difference between mortgage passthrough certificates and CMOs?
Select an Answer: The way that prepayment risk is shared amongst investors. The nature in which mortgages are "securitized." The temporal structure of coupon payments. The number of "securitized" mortgages comprising the underlying asset pool.
The most important difference between passthrough certificates and CMOs relates to the manner in which investors in these securities share prepayment risk. Investors in passthrough certificates share prepayment risk equally, i.e., there is no senior/subordinate structure in reference to principal repayments. If the securitized mortgages underlying a passthrough certificate experience prepayments, these principal payments are allocated equally amongst the investors in the passthrough certificates.
CMOs however, are characterized by a senior/subordinate structure in reference to principal prepayments, and investors in CMOs do not face prepayment risk equally. When issued, CMOs are created in various classes, called "tranches," each of which has a prespecified seniority in accordance to principal repayments. For example, suppose XYZ Mortgage Corporation issues a CMO, and this CMO is comprised of three tranches - tranche A, B, and C. Principal prepayments are to be allocated first to tranche C, and are to continue within this tranche until it has been exhausted. Once the principal of tranche C has been completely repaid, principal prepayments are to be allocated toward tranche B, and are to continue until this tranche is exhausted. Finally, principal prepayments are then to be allocated to the remaining class, tranche A.
As you can see, investors in CMOs do not face prepayment risk equally, and this is the primary difference between passthrough certificates and collateralized mortgage obligations.
Question: Rangoon Distributing, a multinational conglomerate, has announced a new debt issuance. The new debt instruments have been issued at a par value of $10,000 with a 15-year maturity. These debt instruments will not begin to make coupon payments until the tenth year, when a coupon rate of 19.75% per year will continue for the remaining five years.
Which of the following best characterizes these debt instruments?
Select an Answer: none of these answers zero-coupon bonds deferred call bonds variable-rate notes
The debt instruments profiled in this example are best characterized as "deferred coupon bonds." Deferred coupon bonds are bonds whose coupon payments are deferred for a number of years, after which the coupon payments will begin and continue until maturity.
Zero-coupon bonds, on the other hand, are issued at a deep discount from par and pay the full amount of par at maturity. Zero-coupon bonds do not have periodic coupon payments, only the repayment of principal, with the difference between issuance price and redemption price treated as "interest."
"Variable rate notes," which are often referred to as "floating rate notes," have coupon payments that reset at specified points in the future, and are typically tied to an explicit reference rate, such as LIBOR or the prime rate. Finally, remember that debt instruments can be issued with any par value, and this is why the prices of debt instruments are quoted as a percentage of par rather than an explicit dollar amount.
Question: Which of the following methods of distributing newly issued government debt is analogous to a shelf offering?
Select an Answer: ad hoc system pull system tap system calendar rotation system
In a tap system, additional securities of a previously outstanding debt issue are auctioned. Basically, in the tap system, the government announces that it is adding new supply to an outstanding debt issue, and in this respect, the tap system is analogous to a shelf offering.
Both "pull system" and "calendar rotation system" are largely fictitious.
Question: Which of the following statements is not true regarding global bonds?
Select an Answer: In order for an entity to issue global bonds, it is thought that the issuer must have a consistent demand for funds. Freddie Mac and Ginnie Mae have issued global bonds. The first global bond was issued by Citigroup in September 1989. Global bonds are classified as debt issues that are issued and trade in both the U.S. Yankee bond market and the Eurobond market.
A global bond is classified as a debt issue that is issued and traded in both the U.S. Yankee bond market and the Eurobond market. The first global bond was issued in September 1989 by the World Bank. Subsequently, other entities have issued global bonds including Freddie Mac (Freddie Mac Reference Notes), Fannie Mae (Fannie Mae Benchmark Notes), and Citigroup. Additionally, two Canadian Utilities have issued global bonds (Ontario-Hydro and Hydro-Quebec).
Generally, it is believed for an entity to be capable of issuing a global bond, it must satisfy the following three characteristics:
The issuer must possess a high credit rating.
The issuer must have a consistent need for funds.
The amount of funds needed must be large.
Question: A risky asset has the following possible returns:
The expected value of the asset's returns is ________.
Select an Answer: -0.55% -5.55% 0.91% 1.32%
The expected return is a probability weighted average of the returns.