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CFA Level I · CFA Level I Exam · Mortgage-Backed Security (MBS) Instrument and Market Features

A CMBS loan with a 10-year term and a 30-year amortization schedule is most likely to expose investors to which risk near maturity?

The investor faces balloon risk. Because the loan amortizes over 30 years but matures in 10, a large principal balance remains due at maturity. If the borrower cannot refinance, default or extension may occur, lengthening the CMBS tranche's life.

  1. ABalloon risk, because a large principal balance must be refinanced or repaidCorrect
  2. BContraction risk, because borrowers will accelerate repayment
  3. CNegative amortization risk, because the balance grows over time

Explanation

Amortizing over 30 years while maturing in 10 leaves a large unpaid balance at maturity. If the borrower cannot refinance, default or extension follows, which is balloon risk (also called extension risk). Prepayment penalties limit contraction, and the balance falls rather than grows.

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