FRM Exam Part I · Mortgages and Mortgage-Backed Securities

Agency Mortgage Pass-Through Securities Explained for FRM Part I

Updated 11 October 2026 · Fact-checked

An agency pass-through passes borrowers' monthly interest, scheduled principal and prepayments, less servicing and guarantee fees, to investors in a mortgage pool. Ginnie Mae, Fannie Mae or Freddie Mac guarantees payment. To solve questions, get the balance from the factor, apply the net coupon for interest, then add scheduled principal and prepayments.

Understand Agency Mortgage Pass-Through Securities

A mortgage pass-through security is built from a pool of similar mortgages. A lender originates the loans and sells them into a pool. Investors buy shares of the pool. Each month, borrowers pay interest and principal. Servicers collect the payments, keep a fee, and pass the rest to investors. The investors own a pro-rata share of the cash flows, including any early repayment.

The word agency tells you who guarantees the payments. Ginnie Mae (GNMA) is a US government agency. It guarantees timely payment of principal and interest on pools of government-insured or government-guaranteed loans, such as FHA and VA loans. Its guarantee carries the full faith and credit of the US government. Fannie Mae and Freddie Mac are government-sponsored enterprises. They guarantee timely payment on pools of conforming loans, which meet their size and underwriting limits. Their guarantee comes from the enterprises themselves, not explicitly from the US government. Both have been in government conservatorship since 2008. Agency pools carry almost no credit risk to the investor. The main risk is prepayment risk.

Three pool features appear in almost every question. WAC is the weighted average coupon: the average mortgage rate in the pool, weighted by loan balance. WAM is the weighted average maturity: the average remaining term in months, weighted by balance. The factor is the current pool balance divided by the original balance. It starts at 1.0000 and falls as principal is paid. The investor's coupon, the pass-through rate or net coupon, is lower than the WAC. The gap pays the servicing fee and the guarantee fee.

Pass-through cash flow has three parts: interest at the net coupon on the prior balance, scheduled principal, and prepayments. Scheduled principal follows the level-payment amortization schedule. Prepayments are extra principal from borrowers who refinance, move or default (an agency guarantee turns defaults into prepayments for the investor). Because prepayments are uncertain, you cannot know the cash flows in advance. They are projected from a prepayment model.

Most agency pass-throughs trade in the TBA (to-be-announced) market. This is a forward market. The buyer and seller agree the agency, coupon, maturity, price, face amount and settlement date. They do not agree the exact pools. The seller names the pools shortly before settlement, and the pools must meet good-delivery rules. Because the seller picks, the seller tends to deliver the least valuable eligible pools. That makes TBA a liquid market for generic pools. Pools with better features, called specified pools, trade at a premium to TBA.

Key formulas to remember

Pass-through rate (net coupon): Net coupon = WAC − servicing fee − guarantee fee; Investors earn interest at the net coupon, not the WAC. Fees are annual rates.
Pool factor and current balance: Factor = current balance ÷ original balance; current balance = original face × factor; The factor is published monthly. It falls with scheduled principal and prepayments.
Monthly interest to investors: Interest = (net coupon ÷ 12) × beginning-of-month balance; Use the balance at the start of the month. Pass-throughs use a 30/360 convention.
Level monthly mortgage payment: Payment = B × r ÷ (1 − (1 + r)^−n), with r = WAC ÷ 12 and n = WAM in months; Scheduled principal = payment − interest at the WAC. This uses the pool's WAC, not the net coupon.
SMM from CPR: SMM = 1 − (1 − CPR)^(1/12); CPR is annual. SMM is the single monthly mortality rate. Do not divide CPR by 12.
Prepayment amount: Prepayment = SMM × (beginning balance − scheduled principal); Prepayment applies to the balance left after the scheduled principal.
Total investor cash flow and ending balance: Cash flow = net interest + scheduled principal + prepayment; ending balance = beginning balance − scheduled principal − prepayment; Interest is not part of the balance reduction.
100% PSA benchmark: CPR = 0.2% × month (months 1 to 30), then 6% from month 30 on; Other PSA speeds scale this: 200% PSA doubles CPR at each month.

How to solve Agency Mortgage Pass-Through Securities questions

Use this order for any question on pass-through cash flows, pool features or agency differences.

1Identify what is asked: a pool feature (WAC, WAM, factor), a cash flow, a guarantee or agency fact, or a TBA feature.
2Write down the pool data: original face, factor or current balance, WAC, WAM, net coupon and prepayment speed (CPR or PSA).
3Get the beginning balance: original face × factor, if the balance is not given directly.
4Compute interest to investors at the net coupon ÷ 12 on that balance. Use the WAC only to find the borrowers' payment.
5Find scheduled principal: level payment at the WAC and WAM, minus WAC interest on the balance.
6Convert CPR to SMM, then multiply by the balance after scheduled principal to get the prepayment.
7Add net interest, scheduled principal and prepayment for total investor cash flow. Subtract both principal pieces to get the ending balance and next factor.
8Sanity check: investor interest must be below WAC interest, and total principal must be below the beginning balance.

Quickest way: Fast path for pass-through questions

When to use it: Use it when you have about two minutes per question and the numbers are given. Conceptual agency or TBA questions can be answered from the facts alone.

For agency questions, recall: Ginnie = US government agency with full faith and credit backing, FHA/VA loans. Fannie and Freddie = GSEs, conforming loans, in conservatorship, no explicit government backing.
For interest-only questions, skip the amortization. Interest = balance × net coupon ÷ 12.
Check whether the answer needs scheduled principal. If the question gives principal or prepayment amounts, do not recompute them.
On a financial calculator, use PMT with N = WAM, I/Y = WAC ÷ 12, PV = balance, FV = 0 to get the level payment quickly.
For SMM, use the calculator: (1 − CPR)^(1/12) via the y^x key, then subtract from 1.
Eliminate options that use the WAC for investor interest or divide CPR by 12.

Common mistakes in Agency Mortgage Pass-Through Securities

Using the WAC to compute interest paid to investors.
The WAC is the most prominent rate in the question, and it is easy to forget that fees are stripped out.
Fix: Investor interest always uses the net coupon. Use the WAC only for the borrowers' payment and scheduled principal.
Treating Fannie Mae and Freddie Mac guarantees as backed by the full faith and credit of the US government, like Ginnie Mae.
All three are called agencies and all three carry very low credit risk, so the differences blur.
Fix: Ginnie Mae: explicit US government backing. Fannie and Freddie: GSE guarantees, with no explicit government backing, though they have been in conservatorship since 2008.
Dividing CPR by 12 to get SMM.
Monthly rates are usually annual rates ÷ 12, so students apply the same shortcut.
Fix: Use SMM = 1 − (1 − CPR)^(1/12). For a 6% CPR, SMM is about 0.514%, not 0.5%.
Applying SMM to the full beginning balance.
The scheduled principal step is skipped or forgotten.
Fix: Prepayment = SMM × (beginning balance − scheduled principal). Prepayments only apply to balance that has not already been repaid on schedule.
Confusing WAM with loan age, or the factor with the prepayment rate.
These terms all describe the pool's life, and the names sound alike.
Fix: WAM is the remaining term, WALA is the age, and the factor is the remaining balance fraction. A factor of 0.80 means 80% of the original balance is outstanding.
Thinking a TBA trade fixes the specific pools to be delivered.
The word "trade" implies a defined asset, as in a bond purchase.
Fix: A TBA fixes agency, coupon, maturity, price, size and settlement date only. The seller picks the pools shortly before settlement, within good-delivery rules.

Worked examples

Example 1

A Fannie Mae pool has an original face of $200 million and a current factor of 0.8250. The WAC is 4.80% and the net coupon is 4.25%. Find the interest paid to investors for the month, and the amount of WAC interest kept as fees.

Show the solution

Current balance = $200,000,000 × 0.8250 = $165,000,000.
Investor interest = $165,000,000 × 4.25% ÷ 12 = $7,012,500 ÷ 12 = $584,375.
Borrower interest at the WAC = $165,000,000 × 4.80% ÷ 12 = $7,920,000 ÷ 12 = $660,000.
Fees retained = $660,000 − $584,375 = $75,625.
Check: fee rate is 4.80% − 4.25% = 0.55%. $165,000,000 × 0.55% ÷ 12 = $75,625. This matches.

Answer: Investors receive $584,375 of interest. Servicing and guarantee fees take $75,625.

Example 2

A pool has a beginning balance of $100 million, a WAC of 6.00%, a WAM of 360 months and a net coupon of 5.50%. Assume a CPR of 6%. Find the total cash flow to investors for the month and the ending balance.

Show the solution

Monthly rate r = 6.00% ÷ 12 = 0.5%. n = 360.
Level payment factor = 0.005 ÷ (1 − 1.005^−360). 1.005^360 ≈ 6.02258, so 1.005^−360 ≈ 0.16604 and the denominator ≈ 0.83396. Factor ≈ 0.0059955.
Level payment = $100,000,000 × 0.0059955 ≈ $599,551.
Interest at WAC = $100,000,000 × 0.005 = $500,000. Scheduled principal = $599,551 − $500,000 ≈ $99,551.
SMM = 1 − (1 − 0.06)^(1/12) = 1 − 0.994857 ≈ 0.514301%.
Prepayment = 0.00514301 × ($100,000,000 − $99,551) = 0.00514301 × $99,900,449 ≈ $513,789.
Investor interest = $100,000,000 × 5.50% ÷ 12 = $458,333.
Total investor cash flow = $458,333 + $99,551 + $513,789 ≈ $1,071,673.
Ending balance = $100,000,000 − $99,551 − $513,789 = $99,386,660.

Answer: Total investor cash flow is about $1,071,673. The ending balance is about $99,386,660. The next factor is the ending balance divided by the original face.

Exam tips

Know the guarantee hierarchy cold. Questions often ask which agency has explicit US government backing, and the answer is Ginnie Mae.
Always separate the WAC (borrower rate) from the net coupon (investor rate). Many wrong options use the wrong one.
Learn the factor mechanics: balance = original face × factor. Questions can give the factor and ask for cash flow or the next balance.
Expect conceptual TBA questions: what is fixed at trade, who chooses the pools, and why generic pools trade cheaper than specified pools.
Keep the calculation order: scheduled principal first, then prepayment on the remaining balance. Show rounding to the nearest dollar only at the end.

Practice questions from Mortgages and Mortgage-Backed Securities

Agency Mortgage Pass-Through Securities in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CFA Level IMortgage Pass-Through Securities

Agency Mortgage Pass-Through Securities: frequently asked questions

What is the difference between Ginnie Mae, Fannie Mae and Freddie Mac?

Ginnie Mae is a US government agency that guarantees securities backed by government-insured or government-guaranteed loans, with explicit full faith and credit backing. Fannie Mae and Freddie Mac are government-sponsored enterprises that guarantee pools of conforming loans. Their guarantees are not explicitly backed by the US government, and both have been in conservatorship since 2008.

What are WAC and WAM in a mortgage pool?

WAC is the weighted average coupon, meaning the balance-weighted average mortgage rate in the pool. WAM is the weighted average maturity, the balance-weighted average remaining term in months. Both are weighted by loan balance, and both are used to project cash flows.

What is a pool factor?

The factor is the current pool balance divided by the original balance. It starts at 1.0000 and falls as principal is paid or prepaid. Multiply the original face by the factor to get the balance outstanding.

How does the TBA market work?

In a TBA trade, buyer and seller agree the agency, coupon, maturity, price, face amount and settlement date, but not the specific pools. The seller identifies the pools shortly before settlement. This makes agency pass-throughs liquid, as generic pools are interchangeable within the rules.

Why is the pass-through coupon lower than the WAC?

Servicers keep a servicing fee, and the agency charges a guarantee fee for its credit guarantee. These come out of the borrowers' interest before it reaches investors. The remainder is the net coupon, or pass-through rate.