CMB Advanced Portfolio Management 2 — Questions and Answers
Question 1: A portfolio manager notices that a pool of fixed-rate mortgages extends in average life when rates rise. What is this risk called?
- Basis risk
- Contraction risk
- Liquidity risk
- Extension risk (Correct answer)
Correct answer: Extension risk
Extension risk occurs when rising rates slow prepayments and lengthen the expected life of mortgage assets.
Question 2: Why do mortgage-backed securities typically exhibit negative convexity?
- Guarantee fees are tied to Treasury yields
- Servicing fees increase with loan balances
- Borrowers' prepayment option shortens duration as rates fall (Correct answer)
- Coupons reset upward when rates rise
Correct answer: Borrowers' prepayment option shortens duration as rates fall
The embedded prepayment option caps price appreciation when rates fall, producing negative convexity.
Question 3: A 100% PSA prepayment assumption implies what annualized CPR once the pool reaches month 30?
- 2%
- 0.2%
- 10%
- 6% (Correct answer)
Correct answer: 6%
The PSA benchmark ramps 0.2% CPR per month to a constant 6% CPR at month 30 and thereafter.
Question 4: Which metric best captures the price sensitivity of a mortgage asset after accounting for changing cash flows from prepayments?
- Macaulay duration
- Modified duration
- Effective duration (Correct answer)
- Weighted average coupon
Correct answer: Effective duration
Effective duration uses option-adjusted pricing under rate shocks, capturing prepayment-driven cash-flow changes.
Question 5: A lender holds a large concentration of loans in a single metropolitan area. Which risk is most directly elevated?
- Prepayment model risk
- Pipeline fallout risk
- Counterparty settlement risk
- Geographic concentration credit risk (Correct answer)
Correct answer: Geographic concentration credit risk
Concentration in one market exposes the portfolio to correlated defaults from a local economic or price shock.
Question 6: What does the option-adjusted spread (OAS) on a mortgage asset represent?
- Spread between note rate and servicing fee
- Difference between WAC and pass-through rate
- Nominal spread over the 10-year Treasury
- Spread over the benchmark curve after removing the cost of the embedded prepayment option (Correct answer)
Correct answer: Spread over the benchmark curve after removing the cost of the embedded prepayment option
OAS strips out the value of the borrower's option, leaving compensation for credit, liquidity, and model risk.
Question 7: Under CECL, how must a lender estimate credit losses on held-for-investment mortgage loans?
- Losses over the next 12 months only
- Only losses that are probable and incurred at the reporting date
- Expected losses over the contractual life adjusted for prepayments (Correct answer)
- Only losses on loans 90+ days delinquent
Correct answer: Expected losses over the contractual life adjusted for prepayments
CECL requires lifetime expected credit loss estimates using reasonable and supportable forecasts.
