Definitions and Details
Pass-through certificates (or securities) are investment vehicles representing a share in a pool of mortgages. These securities are issued by mortgage bankers and marketed to investors. As borrowers make monthly mortgage payments, these payments “pass through” the intermediary and are distributed to the certificate holders based on their ownership stake.
Key Characteristics
- Often backed or guaranteed by entities such as Ginnie Mae (Government National Mortgage Association).
- They offer liquidity to mortgage issuers by converting pools of mortgages into marketable securities.
- Typically offer a steady stream of income to investors.
Examples
- Fannie Mae MBS: Fannie Mae (Federal National Mortgage Association) produces mortgage-backed securities similar to pass-through certificates. Investors receive principal and interest payments from the pool of collected mortgages.
- Freddie Mac Participation Certificates: Issued by Freddie Mac (Federal Home Loan Mortgage Corporation), these securities pass mortgage payments to the security holders.
- Ginnie Mae Pass-Through Securities: Guaranteed by Ginnie Mae, offering a high degree of security, these pass-through certificates are popular due to their government guarantee.
Frequently Asked Questions (FAQs)
What are the benefits of investing in pass-through certificates?
Pass-through certificates offer investors steady income streams, lower risk due to guarantees by agencies like Ginnie Mae, and relatively higher liquidity compared to holding individual mortgages.
What are the risks associated with pass-through securities?
The main risks include interest rate risk, prepayment risk, and the potential reduction in yield if the underlying borrowers prepay their mortgages.
How do pass-through securities compare to Collateralized Mortgage Obligations (CMOs)?
While both are types of Mortgage-Backed Securities (MBS), CMOs are structured with multiple tranches that have different risk levels and maturity dates, whereas pass-through securities are simpler, passing payments directly from the pool to the investors.
Collateralized Mortgage Obligation (CMO)
A type of mortgage-backed security that divides the pool of mortgages into arbitrary other tranches with varying risk, return, and payoff timelines amongst investors.
Mortgage-Backed Securities (MBS)
A broader category encompassing all types of securities created from pools of mortgage loans, including both pass-through certificates and CMOs.
Ginnie Mae
The Government National Mortgage Association, an agency offering guarantees for mortgage-backed securities, making them safer for investors.
Prepayment Risk
The risk that the mortgage borrowers will pay off their loans earlier than expected, impacting the yield that investors would earn on pass-through certificates.
Online Resources
References
- U.S. Securities and Exchange Commission. “Investor Bulletin: Mortgage-Backed Securities.” SEC.gov.
- Investopedia. “Mortgage-Backed Security (MBS).” Investopedia.
- Ginnie Mae. “Pass-Through Securities.” GinnieMae.gov.
Suggested Books for Further Study
- “The Handbook of Mortgage-Backed Securities” by Frank J. Fabozzi
- “Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques” by Bhoumik Chattopadhyay
- “Structured Finance and Collateralized Debt Obligations: New Developments in Cash and Synthetic Securitization” by Janet M. Tavakoli
Real Estate Basics: Pass-Through Certificates Fundamentals Quiz
### What entity often guarantees pass-through certificates?
- [ ] Freddie Mac
- [ ] The IRS
- [x] Ginnie Mae
- [ ] Fannie Mae
> **Explanation:** Ginnie Mae, or the Government National Mortgage Association, often guarantees pass-through certificates, providing a high level of security to investors.
### What is a primary characteristic of a pass-through security?
- [ ] It offers variable return rates based on market conditions.
- [ x ] It distributes collected mortgage payments to investors.
- [ ] It is backed solely by private mortgage lenders.
- [ ] It has tranches with varying risk levels and pay-off times.
> **Explanation:** Pass-through securities collect mortgage payments and distribute these payments directly to investors, providing them with income based on their ownership share.
### Which risk is associated with the early repayment of underlying mortgages in a pass-through security?
- [ ] Inflation risk
- [ ] Credit risk
- [x] Prepayment risk
- [ ] Currency risk
> **Explanation:** Prepayment risk is the risk that borrows will repay their mortgages earlier than expected, reducing the yield for investors.
### How do pass-through certificates mainly differ from CMOs?
- [ ] Pass-through certificates are not guaranteed by any agency.
- [ ] CMOs offer a fixed return rate.
- [x] Pass-through certificates pass mortgage payments directly to investors.
- [ ] CMOs have fewer tranches compared to pass-through certificates.
> **Explanation:** Pass-through certificates pass collected monthly mortgage payments directly to the investors, while CMOs have multiple tranches with varying risk levels and payout times.
### What is an advantage of pass-through certificates for mortgage issuers?
- [ ] It decreases their mortgage origination risk.
- [ ] It eliminates need to manage the mortgage ongoing.
- [x] It provides them with liquidity.
- [ ] It increases their interest rate exposure.
> **Explanation:** Issuers gain liquidity as they can convert pools of mortgage loans into marketable securities that attract investors.
### What type of income do investors receive from pass-through certificates?
- [x] Steady income from mortgage payments.
- [ ] Dividends based on company profits.
- [ ] Fees from borrower services.
- [ ] Capital gains from secondary market trading.
> **Explanation:** Investors receive steady income in the form of combined interest and principal payments from the borrow only comparable to acquiring expected certificates’ underlying mortgage pool securitization.
### Which of these terms is directly related to pass-through certificates?
- [ ] Variable annuity
- [x] Mortgage-Backed Security (MBS)
- [ ] Rent roll
- [ ] Cash flow statement
> **Explanation:** Pass-through certificates fall under the broader category of Mortgage-Backed Securities (MBS), involving mortgages pooled to back the issued security.
### What makes pass-through securities more liquid compared to holding individual loans?
- [ ] They are not regulated by government bodies.
- [ ] They exclude government-backed mortgages.
- [x] They are marketable securities that can be sold in secondary markets.
- [ ] They are limited to local real estate markets.
> **Explanation:** Pass-through securities are marketable and can be traded in secondary markets, making them more liquid than holding individual mortgage loans without structured bonds broadcast.
### Which of these entities is known for issuing pass-through certificates?
- [ ] Securities and Exchange Commission (SEC)
- [x] Fannie Mae
- [ ] Internal Revenue Service (IRS)
- [ ] Consumer Financial Protection Bureau (CFPB)
> **Explanation:** Fannie Mae, along with Freddie Mac and Ginnie Mae, is known for issuing pass-through certificates representing pools’ mortgages incentivizing for tax-beneficial investments, loans, and real estate yields closely inspection for safety net administration endowments.
### Pass-through certificates offer income to investors based on?
- [ ] Rental property income
- [ ] Company dividends
- [x] Monthly mortgage payments
- [ ] Capital appreciation
> **Explanation:** Investors in pass-through certificates receive their income based on the monthly mortgage payments made by borrowers within the mortgage pool of administering distribution.
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