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Chap028 - Chapter Twenty Eight Securitization Chapter...

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Chapter Twenty Eight Securitization Chapter Outline Introduction The Pass-Through Security GNMA FNMA FHLMC The Incentives and Mechanics of Pass-Through Security Creation Prepayment Risk on Pass-Through Securities Prepayment Models The Collateralized Mortgage Obligation (CMO) Creation of CMOs Other CMO Classes The Mortgage-Backed Bond (MBB) Innovations in Securitization Mortgage Pass-Through Strips Securitization of Other Assets Can All Assets Be Securitized? Summary 97
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Solutions for End-of-Chapter Questions and Answers: Chapter Twenty Eight 1. What has been the effect of securitization on the asset portfolios of financial institutions? In addition to serving as another mechanism to hedge interest rate exposure gaps, securitization has provided a method to make asset portfolios more liquid, has provided an important source of fee income, and has helped to reduce the effects of regulatory taxes. 2. What are the primary functions of GNMA? What is timing insurance? GNMA sponsors mortgage-backed securities programs by FIs and serves as a guarantor to investors in mortgage-backed securities. Timing insurance guarantees that the holder of pass- through securities will receive interest and principal payments at the calendar date promised. This service is provided in many mortgage-backed securities offerings by GNMA. 3. How does FNMA differ from GNMA? FNMA is a private corporation whose stock trades on major exchanges, while GNMA is directly owned by the government. Whereas GNMA sponsors mortgage-backed programs, FNMA actually creates pass-through securities by buying and holding mortgages on its balance sheet. These mortgage purchases often are financed by the issuance of bonds in the capital markets. The securities that are created are called mortgage-backed securities (MBS). 4. How does FHLMC differ from FNMA? How is it the same? The Federal Home Loan Mortgage Corporation performs duties similar to FNMA for the savings bank industry. Privately owned with a line of credit from the Treasury, FNMA buys mortgage pools and swaps MBS for loans. FNMA also sponsors conventional loan pools and FHA/VA mortgage pools, and provides timing insurance on the securities it issues. 5. What three levels of regulatory taxes do FIs face when making loans? How does securitization reduce the levels of taxation? The three levels of taxes faced by FIs when making loans are; a) capital requirements on loans to protect against default; b) reserve requirements on demand deposits for funding the loans; and c) deposit insurance to protect the depositors. If the loans are securitized, FIs end up only servicing the loans since the loans no longer are on the balance sheet. As a result, no capital is required to protect against default risk. Further, reserve requirements and deposit insurance will be reduced if liabilities are also reduced. However, if the cash proceeds from the loan sales are used to invest in other assets, then the taxes will still remain in place.
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