A pass-through mortgage-backed security:

Question

BlackTom AI · Accepted Answer

Consider the core concept of a pass-through mortgage-backed security and what it does with the cash flows from the underlying pool of mortgages.
Option A: 'Provides investors with a known, fixed maturity date.' This is not generally true for pass-throughs, because the timing of principal repayments depends on the performance of the underlying loans and may be accelerated by prepayments, extending or shortening the expected maturity, so a fixed maturity date is not guaranteed.
Option B: 'Guarantees investors will be protected against prepayment risk.' In fact, pass-throughs expose investors to prepayment risk because borrowers may refinance or pay off their loans earlier than expected, which can alter anticipated cash flows; there is no guarantee against this risk.
Option C: 'Passes all principal and interest payments from the underlying mortgages to investors on a pro rata basis.' This statement aligns with the standard structure of pass-through securities: borrowers’ payments flow through to security holders in proportion to their ownership of the pool, after servicing and administrative fees are deducted. The pro rata distribution of both P&I is the defining feature.
Option D: 'Completely eliminates credit risk for all investors.' This is incorrect because pass-throughs carry credit risk tied to the originating mortgages and the underlying pool; default risk and credit concerns remain, albeit mitigated through diversification and guarantees in some structures, but not eliminated entirely.
In summary, the description in Option C accurately captures the essential mechanism of a pass-through MBS, while the other options describe features that are not characteristic of standard pass-through securities.

BU.231.710.51.FA25 The Final Exam

A pass-through mortgage-backed security:

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