CFA Level I · CFA Level I Exam · Fixed-Income Securitization
A investor holds a mortgage pass-through security backed by a pool of fixed-rate, fully amortizing mortgages. The weighted average coupon (WAC) of the pool is 5.0% and the pass-through rate is 4.5%. The difference between the two rates is most likely explained by:
The gap between the pool's weighted average coupon and the pass-through rate mostly reflects servicing and other fees (such as guarantee fees) retained from borrowers' payments before the remainder is passed through to investors in the security.
- Aservicing and other fees retained from the mortgage paymentsCorrect
- Bthe prepayment penalty collected from borrowers
- Cthe default insurance premium paid to bondholders
Explanation
The pass-through rate is the WAC less the servicing and guarantee fees retained by the servicer and guarantor. Prepayment penalties are not the source of this spread, and insurance premiums are paid by the pool, not to bondholders.
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