CMB Mortgage Risk Management 2 — Questions and Answers
Question 1: After a lender issues a rate lock to a borrower but before the loan is sold, which risk is the lender most directly exposed to?
- Credit risk from borrower default
- Interest rate (price) risk on the locked loan (Correct answer)
- Servicing advance risk
- Title defect risk
Correct answer: Interest rate (price) risk on the locked loan
If market rates rise after the lock, the loan's sale value falls, so the locked pipeline carries price risk until it is sold or hedged.
Question 2: In pipeline management, what does the term 'pull-through rate' measure?
- The share of applications that are approved by underwriting
- The share of closed loans sold within 30 days
- The percentage of rate-locked loans expected to actually close and fund (Correct answer)
- The percentage of loans that prepay in the first year
Correct answer: The percentage of rate-locked loans expected to actually close and fund
Pull-through is the expected percentage of locked loans that will close, and it drives how much of the pipeline gets hedged.
Question 3: Which instrument do mortgage bankers most commonly use to hedge a pipeline of locked conforming fixed-rate loans?
- Forward sales of TBA agency MBS (Correct answer)
- Purchases of long-dated Treasury bonds
- Equity index futures
- Fixed-income mutual funds
Correct answer: Forward sales of TBA agency MBS
Selling TBA MBS forward offsets value losses on locked conforming loans if rates rise.
Question 4: Rates drop sharply and many locked borrowers walk away to relock elsewhere. A lender that hedged using a fixed pull-through assumption is most likely to face which problem?
- It is under-hedged and loses on the closed loans
- It is over-hedged and loses on its short TBA positions (Correct answer)
- It is fully protected because forward sales are always matched
- It gains on both the loans and the hedge
Correct answer: It is over-hedged and loses on its short TBA positions
Higher fallout leaves the lender short more TBAs than loans it can deliver, so it loses on the hedge when prices rise.
Question 5: What is the main risk trade-off a lender makes when selling loans on a best-efforts basis instead of a mandatory delivery basis?
- It takes on more credit risk but gets a higher price
- It gives up servicing rights but avoids repurchase risk
- It shifts fallout risk to the investor in exchange for a lower price (Correct answer)
- It avoids rep and warrant obligations entirely
Correct answer: It shifts fallout risk to the investor in exchange for a lower price
Under best efforts the lender only delivers loans that close, so the investor carries fallout risk and pays less for that option.
Question 6: A lender commits to deliver $5 million in loans under a mandatory commitment but can deliver only $4 million. What typically settles the shortfall?
- A pair-off fee based on the market price change (Correct answer)
- An automatic extension at no cost
- Cancellation with no financial consequence
- Substitution with jumbo loans at par
Correct answer: A pair-off fee based on the market price change
Undelivered mandatory volume is usually paired off, and the lender pays any adverse price change.
Question 7: In interest rate risk management, what does duration measure for a mortgage asset or hedge position?
- The remaining term to maturity in months
- How long the loan stays in the pipeline
- The average time until the first payment default
- The sensitivity of its price to changes in interest rates (Correct answer)
Correct answer: The sensitivity of its price to changes in interest rates
Duration estimates the percentage price change for a given change in yield, which is how hedge ratios are sized.
