CFA Level I · CFA Level I Exam · Mortgage-Backed Security (MBS) Instrument and Market Features
A CMBS pool contains loans with balloon payments due at maturity. The borrower on one loan cannot refinance the balloon at maturity. This situation is best described as:
This is balloon risk, which is a form of extension risk. The borrower cannot refinance the large final payment, so the lender may extend the loan or work it out, delaying principal to CMBS investors beyond the expected maturity and raising credit exposure.
- Aballoon risk, a form of extension riskCorrect
- Bprepayment risk, a form of contraction risk
- Cdefault risk eliminated by call protection
Explanation
Balloon risk is the chance the borrower cannot repay or refinance the balloon at maturity. If the loan is extended or the term lengthens while workout occurs, this is extension of the cash flows beyond the expected term. It is not prepayment, and call protection does not remove default risk.
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