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

An agency mortgage pass-through security is backed by a pool of fixed-rate mortgages with a weighted average coupon (WAC) of 5.00%. The pass-through coupon rate paid to investors is 4.50%. Which statement best describes the 0.50% difference?

The 0.50% gap between the pool's WAC and the pass-through coupon is the servicing and guarantee fee retained before cash flows go to investors. It pays the servicer and the agency that guarantees timely interest and principal, not a prepayment penalty or a risk premium.

  1. AIt is the servicing and guarantee fee retained before payments reach investorsCorrect
  2. BIt is the prepayment penalty collected from borrowers
  3. CIt is the accrued interest premium paid by the buyer at settlement
  4. DIt is the extension risk premium built into the pool

Explanation

The pass-through rate equals the WAC less servicing and guarantee fees. The 0.50% spread compensates the servicer and the agency guaranteeing timely payment of principal and interest. Prepayment penalties are not generally part of this spread on standard residential agency pools.

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