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

Compared with a pass-through security priced at par, a mortgage pass-through priced at a significant premium to par is most likely to experience which result if prepayments accelerate?

The premium pass-through's yield falls. The investor paid above par but gets principal back at par, so faster prepayments mean the premium is written off over a shorter time, reducing the realized yield. Discount securities benefit from faster prepayments, but premium securities are hurt.

  1. AA lower yield, because the premium paid is amortized over a shorter lifeCorrect
  2. BA higher yield, because principal is returned at par sooner
  3. CAn unchanged yield, because the coupon rate is fixed

Explanation

A premium buyer pays more than par but receives principal back at par. Faster prepayments return par sooner, so the premium loss is spread over a shorter period and realized yield falls. A discount security would gain instead.

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