Mortgage Backed Securities

First Principles Thinking: decision rule

B is correct. The key criterion is whether default still exposes the borrower to further claims. The module states that strategic default is less likely under recourse loans because the lender can pursue the borrower for the shortfall beyond the collateral. That weakens the incentive to walk away.

Why option A is incorrect. Non-recourse status can strengthen the incentive to default strategically on an underwater property.

Why option C is incorrect. Falling home prices and non-recourse treatment point in the opposite direction by making walk-away behavior more plausible.

First Principles Thinking: causal test

C is correct. The assertion is true because the curriculum says CMBS may consist of only a few commercial mortgages, so one default can matter a lot. The reason is false because that description belongs more closely to diversified RMBS pools, not to concentrated CMBS pools.

Options A and B fail because the reason is false. Option D fails because the assertion is explicitly supported by the CMBS-risk discussion.

First Principles Thinking: causal test

B is correct. Both statements appear in the CMBS section. However, the need for deep legal and commercial analysis does not explain why European CMBS often carry floating rates that may be capped; it is a separate structural observation.

Option A fails because the reason is not the stated causal explanation. Options C and D fail because neither statement is false.

First Principles Thinking: calculation rule

B is correct. First compute NOI from the given facts: $60{,}000 - 9{,}500 = 50{,}500$. Then $\text{DSC} = 50{,}500 / 36{,}110 = 1.3985\times$, which rounds to 1.40x.

Why option A is incorrect. It would imply NOI is materially below debt service, which is inconsistent with the numbers given.

Why option C is incorrect. That value belongs to a different CMBS example with a much larger NOI and debt-service pair.

First Principles Thinking: classification rule

C is correct. Each statement is directly supported by the module. Faster-than-expected principal return produces contraction risk and shortens life, slower-than-expected principal return produces extension risk and lengthens life, and time tranching creates classes with different expected maturities. The count is three.

Why option A is incorrect. The curriculum supports more than one of the statements.

Why option B is incorrect. Item III is also accurate, so the total reaches three rather than two.

First Principles Thinking: causal test

B is correct. Both statements are supported by the module. The reason correctly describes what the penalty does, but it does not by itself explain the cross-market observation that such penalties are more prevalent in Europe than in the United States.

Option A fails because the reason is useful but not the stated explanation for the geographic prevalence. Options C and D fail because neither statement is false.

First Principles Thinking: classification rule

B is correct. The module describes prime loans as having strong borrowers, low DTI, substantial equity, and a first lien on the property. A second lien subordinated to another loan is identified with riskier subprime lending. Thus, Items I and II satisfy the prime-loan test while Item III does not, so the count is two.

Why option A is incorrect. The curriculum gives two qualifying traits here, not one.

Why option C is incorrect. Item III violates the prime-loan description because subordinated second liens are associated with weaker credit profiles.

First Principles Thinking: decision rule

C is correct. The governing criterion is the presence of call protection. The CFA Curriculum explicitly says CMBS offer investors call protection at either the structural or individual-loan level, and for that reason they trade more like corporate bonds than RMBS.

Why option A is incorrect. The module contrasts CMBS with RMBS by noting CMBS may contain only a few commercial mortgages, not thousands of homogeneous loans.

Why option B is incorrect. CMBS still carry default and extension-related risks; call protection does not remove default risk.

First Principles Thinking: calculation rule

B is correct. Use a value-weighted average of scheduled repayment times: $[(3 \times 2) + (2 \times 3)] / 5 = 12/5 = 2.4$ years. The calculation uses the face-value weights of the two purchased tranches and the no-prepayment scheduled repayment dates.

Why option A is incorrect. It understates the weighted average by giving too little weight to the three-year Class C position.

Why option C is incorrect. It overstates the average as if the later tranche dominated more than its EUR 2 million weight permits.

First Principles Thinking: causal test

D is correct. The assertion reverses the curriculum's definitions. In a non-recourse mortgage, the lender can look only to the property. The reason is true because recourse status lets the lender pursue other assets or income and therefore weakens the strategic-default incentive.

Options A, B, and C fail because the assertion is false. Only the reason survives the curriculum test.

First Principles Thinking: calculation rule

C is correct. Apply the curriculum's WAM rule by weighting each remaining maturity by current balance and dividing by the total balance. The result is about 235.6 months, which rounds to 236 months.

Why option A is incorrect. It is materially below the weighted result and places too little influence on the large 324-month mortgage.

Why option B is incorrect. It is closer, but still below the balance-weighted maturity implied by the data.

First Principles Thinking: decision rule

A is correct. The curriculum explains that sequential-pay structures protect the shorter tranche against extension risk because principal is prioritized to that tranche before later tranches receive principal. An investor trying to avoid delayed repayment therefore favors the earliest tranche.

Why option B is incorrect. The longest tranche is exposed to more extension uncertainty rather than protected from it.

Why option C is incorrect. A residual tranche collects remaining cash flow and is appropriate for investors willing to assume substantial risk, not for those trying to minimize extension risk.

First Principles Thinking: classification rule

C is correct. Each statement is directly supported by the module. Fees reduce the pass-through coupon below the pool's weighted average mortgage rate. WAM uses remaining months weighted by each mortgage's outstanding current balance. Senior tranches are described as having less exposure to prepayment and default risk. The count is therefore three.

Why option A is incorrect. The curriculum supports more than one statement here.

Why option B is incorrect. Item III is also accurate, so the total is not limited to two.

First Principles Thinking: causal test

A is correct. The module explains that sequential-pay structures route principal to the first tranche until its balance reaches zero. That payment rule is exactly why the shorter tranche receives protection against extension risk from the longer tranches.

The other classifications fail because neither statement is false, and the reason is not merely associated with the assertion; it is the mechanism that creates the protection.

First Principles Thinking: decision rule

A is correct. The defining criterion is slower-than-expected principal repayment. The CFA Curriculum links that outcome to rising rates because refinancing falls and new home purchases may be delayed, stretching out cash flows. That is extension risk.

Why option B is incorrect. Faster refinancing when rates fall creates contraction risk, not extension risk.

Why option C is incorrect. Reduced upside price appreciation is an adverse consequence of contraction risk, but it does not identify the condition that intensifies extension risk.

First Principles Thinking: calculation rule

A is correct. Sum the mortgages and divide by the sum of property values: $83{,}000{,}000 / 110{,}000{,}000 = 0.7545$, which is closest to 0.75.

Why option B is incorrect. It is close to the first property's individual mortgage-to-value ratio rather than the portfolio ratio.

Why option C is incorrect. It is close to the third property's individual ratio, not the combined portfolio calculation.

First Principles Thinking: classification rule

B is correct. The CFA Curriculum states that declining rates typically increase refinancing and actual prepayments, which creates contraction risk. That faster principal return forces reinvestment at lower rates. Extension risk is tied to slower-than-expected principal repayment, which is associated with rising rates rather than falling rates. Therefore, Items I and II qualify and the count is two.

Why option A is incorrect. More than one statement satisfies the criterion because both Items I and II are consistent with the module.

Why option C is incorrect. Item III fails because extension risk is linked to higher rates and slower refinancing, not lower rates.

First Principles Thinking: classification rule

A is correct. Only Item I matches the curriculum. In a recourse loan, the lender may pursue the borrower's other assets or income for the shortfall after the collateral sale. In a non-recourse loan, the lender can look only to the property, and strategic default is less likely under recourse rather than non-recourse treatment. The count is one.

Why option B is incorrect. Item II and Item III both reverse the recourse versus non-recourse logic in the module.

Why option C is incorrect. All three cannot qualify because only the first statement is consistent with the curriculum.

First Principles Thinking: decision rule

B is correct. The module states that lenders use prepayment penalties to offset the difference between the contract rate and prevailing mortgage rates when a borrower prepays after rates decline. The purpose is to reduce the incentive to refinance and to compensate the lender for that adverse rate environment.

Why option A is incorrect. A penalty may deter prepayment, but it does not directly rewrite the stated maturity.

Why option C is incorrect. Recourse is a legal claim feature, not something created by a prepayment fee.

First Principles Thinking: calculation rule

C is correct. Apply the curriculum formula $\text{LTV} = \text{loan amount} / \text{property value}$. Here, $33{,}165{,}000 / 36{,}850{,}000 = 0.90$, or 90.0%.

Why option A is incorrect. It is below the ratio produced by dividing the mortgage amount by the property value.

Why option B is incorrect. It is close enough to be tempting, but the exact module example produces 90.0%, not 88.0%.

First Principles Thinking: classification rule

B is correct. Agency RMBS includes the federal-agency sector and the GSE-guaranteed sector, but the module distinguishes the federal government's full faith and credit from the GSE's own guarantee. It also states that private-label or non-agency RMBS may use credit enhancement such as subordination. Therefore, Items I and III are accurate while Item II is not, so the count is two.

Why option A is incorrect. Two, not one, of the listed statements follow the curriculum definitions.

Why option C is incorrect. Item II overstates the nature of a GSE guarantee by treating it as full faith and credit.

First Principles Thinking: classification rule

A is correct. Only Item III matches the module. Structural call protection in CMBS comes from sequential-pay tranches. A prepayment penalty point equals 1.00% of the outstanding loan balance, not property value. Under defeasance, the replacement government-securities portfolio is constructed so that its value is zero after the last scheduled payment. The count is one.

Why option B is incorrect. Item I and Item II both fail the curriculum's definitions, so there are not two accurate statements.

Why option C is incorrect. All three do not qualify because only the structural-call-protection statement is accurate.

First Principles Thinking: causal test

A is correct. The module states that falling rates lead homeowners to refinance, which raises actual prepayments above forecast. Earlier-than-expected return of principal is exactly the mechanism of contraction risk, so the reason explains the assertion.

The other answer choices fail because neither statement is false and the reason is the direct causal chain described in the curriculum.

First Principles Thinking: calculation rule

C is correct. Weight each mortgage coupon by its mortgage amount and divide by total mortgage value: $[(27 \times 4.00\%) + (44 \times 3.00\%) + (12 \times 5.00\%)] / 83 = 3.61\%$ approximately.

Why option A is incorrect. That is the weighted average coupon payment for the four CMBS tranches in the practice set, not the weighted proceeds from the mortgages.

Why option B is incorrect. It is the straight average style distractor rather than the mortgage-amount-weighted result.

First Principles Thinking: decision rule

C is correct. The decision rule is the guarantee source, not simply the collateral type or the existence of enhancement. The CFA Curriculum classifies private-label residential MBS without federal-agency or GSE guarantee as non-agency RMBS, even when credit enhancement such as insurance or subordination is present.

Why option A is incorrect. Credit enhancement reduces credit risk but does not convert a private-label issue into agency RMBS.

Why option B is incorrect. Residential collateral defines RMBS broadly, but agency status still depends on the federal-agency or GSE guarantee distinction.

First Principles Thinking: calculation rule

A is correct. Weight each mortgage rate by its current outstanding balance relative to the total current balance of CAD 1,496,000. The weighted result is approximately 4.73%, which is the pool's WAC under the module's definition.

Why option B is incorrect. It is lower than the balance-weighted result and is closer to an imprecise shortcut than to the required calculation.

Why option C is incorrect. It is too high and ignores the substantial weight in lower-rate mortgages.

First Principles Thinking: causal test

C is correct. The RMBS section defines WAC using each mortgage's outstanding current balance as the weight relative to the pool's current total balance. The reason is false because original balance is not the required weighting basis in this module.

Options A and B fail because the reason is not true. Option D fails because the assertion is directly supported by the curriculum.

First Principles Thinking: decision rule

C is correct. Balloon risk turns on whether the borrower can refinance or sell the property to meet the large maturity payment. A weak buyer market makes sale proceeds harder to realize and therefore increases the risk that the balloon payment cannot be made.

Why option A is incorrect. A higher DSCR indicates stronger property cash-flow support and tends to reduce balloon risk.

Why option B is incorrect. A lower LTV gives the lender more collateral cushion and also tends to reduce balloon risk.