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

Compared with agency MBS, non-agency MBS investors face which additional risk?

Non-agency MBS investors bear the credit risk of the underlying borrowers because no government agency or GSE guarantees principal and interest. Agency MBS are guaranteed, so their investors mainly face prepayment and interest rate risk rather than default risk.

  1. ACredit risk of the underlying borrowers, since there is no government or GSE guarantee of principal and interestCorrect
  2. BPrepayment risk, which is absent in agency MBS
  3. CNo exposure to interest rate risk
  4. DExtension risk, which affects only non-agency pools

Explanation

Agency MBS carry a guarantee of timely payment of principal and interest by Ginnie Mae, Fannie Mae or Freddie Mac. Non-agency MBS have no such guarantee, so investors bear borrower credit risk, managed through tranching and credit enhancement. Both types face prepayment, extension and interest rate risk.

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