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FRM Part I · FRM Exam Part I · Mortgages and Mortgage-Backed Securities

A pass-through security is backed by a pool of fixed-rate mortgages with a weighted average coupon (WAC) of 5.50%. The pass-through rate paid to investors is 5.00%. What does the 0.50% difference represent?

The 0.50% gap between the pool's weighted average coupon and the pass-through rate represents servicing and guarantee fees retained before cash flows reach investors. Borrowers pay the WAC, but investors receive only the net coupon after these fees are deducted.

  1. AServicing and guarantee fees retained before cash flows are passed to investorsCorrect
  2. BPrepayment penalty collected from borrowers and kept by the issuer
  3. CAccrued interest on the pool during the delay between payment and distribution
  4. DCredit spread compensating investors for default risk in the pool

Explanation

The WAC is the average rate borrowers pay. The pass-through rate is lower because the servicer's fee and the agency's guarantee fee are deducted before payments go to investors. The spread is not a penalty, not delay accrual, and not credit compensation, since agency pools carry a guarantee.

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