Definition
A Mortgage-Backed Security (MBS) is a financial instrument that is created from the pooling of mortgage loans bought from the banks that issued them. These loans are bundled together and sold as securitized assets to investors. The MBS allows the issuing bank to remove the loans from its balance sheet, thereby freeing up capital and enabling further lending.
Examples
- Residential Mortgage-Backed Security (RMBS): An MBS backed by residential mortgages, like single-family homes, townhouses, and apartments.
- Commercial Mortgage-Backed Security (CMBS): It involves the securitization of commercial property loans, such as office buildings, malls, hotels, and industrial properties.
- Agency MBS: These are issued by government-sponsored enterprises (GSEs) like Fannie Mae, Freddie Mac, or Ginnie Mae, offering an implicit or explicit government guarantee.
- Non-Agency MBS: Issued by private entities without any government guarantees, carrying higher risk and potentially higher yields.
Frequently Asked Questions
What are the benefits of investing in MBS?
Investing in MBS provides regular cash flow from the mortgage payments made by the homeowners. They can also offer higher yields compared to other debt instruments, depending on their risk profile.
What risks are associated with MBS?
The primary risks include prepayment risk, where homeowners pay off their mortgages early, resulting in lower returns; interest rate risk, impacting the value of the securities as rates fluctuate; and credit risk, particularly with non-agency MBS that lack government guarantees.
How does an MBS work?
A bank or mortgage lender sells its mortgage portfolio to a special purpose vehicle (SPV), which pools the loans and transforms them into securities. These securities are then sold to investors, who receive payments derived from the underlying mortgage payments.
What is a Collateralized Mortgage Obligation (CMO)?
A CMO is a type of MBS that divides the pool of mortgages into tranches with varying risk levels, interest rates, and maturities. This structure aims to provide more targeted risk exposures to investors.
How does an agency MBS differ from a non-agency MBS?
Agency MBS are backed by GSEs like Fannie Mae, Freddie Mac, or Ginnie Mae, which offer government guarantees, making them generally safer. Non-agency MBS do not have such guarantees and carry a higher risk of default but may offer potentially higher yields.
Related Terms
- Collateralized Mortgage Obligation (CMO): A complex type of MBS that divides the mortgage pool into tranches, each with different levels of risk and returns.
- Mortgage-Backed Certificate: Similar to an MBS but usually refers to a specific form where certificates are issued representing ownership interest in the underlying mortgages.
- Tranche: A slice of an MBS or other structured product, each with unique risk, return, and maturity characteristics.
- Prepayment Risk: The risk that borrowers might pay off their mortgages early, affecting the returns on MBS.
- Interest Rate Risk: The risk that fluctuations in interest rates will affect the value of the MBS.
Online References
- Investopedia: Mortgage-Backed Security (MBS)
- Wikipedia: Mortgage-Backed Security
- Securities and Exchange Commission (SEC) on MBS
Suggested Books for Further Studies
- “The Handbook of Mortgage-Backed Securities” by Frank J. Fabozzi
- Comprehensive guide covering various aspects of MBS, including structuring, analysis, and valuation.
- “Fixed Income Analysis” by Barbara S. Petitt and CFA Institute
- Offers insights into fixed income markets and instruments, including MBS.
- “Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques” by Anand K. Bhattacharya and Frank J. Fabozzi
- Detailed examination of MBS and CMO structures, valuation techniques, and analytical strategies.
Fundamentals of Mortgage-Backed Security: Finance Basics Quiz
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