What choice of words can you think of for each gap?
_______= one word
______(1/2) = think of one or two word combinations
WTD = what’s the difference between these underlined items
(TENSE) = what tenses are possible / what’s the difference
Asset-backed securities (ABS) and mortgage-backed securities (MBS) are two important types of asset classes. MBS are securities created from the 1)____________ of mortgages, and then sold to interested investors, whereas ABS have evolved out of MBS and are created from the pooling of non-mortgage assets. These are usually 2)_____________ by credit card receivables, home equity loans, student loans and auto loans. The ABS market was developed in the 1980s and has become increasingly important to the U.S. debt market. In this article, we will go through the structure, some examples of ABS and valuation.
There are three parties involved in the structure of ABS and MBS: the seller, the issuer and the investor. Sellers are the companies that 3)____________loans and sell them to issuers. They also take the responsibility of acting as the servicer, collecting principal and interest payments from borrowers. Issuers buy loans from sellers and pool them together to 4)__________ABS or MBS to investors. They can be a third-party company or special-purpose vehicle (SPV). ABS and MBS benefit sellers because they can be removed from the balance sheet, allowing sellers to 5)_____________additional funding. Investors of ABS and MBS are usually institutional investors and they use ABS and MBS to obtain 6)___________yields than government bonds, as well as to provide a way to diversify their portfolios.
Both ABS and MBS have prepayment risks, though these are especially 7)_________________for MBS. Prepayment risk is the risk of borrowers paying more than their required monthly payments, 8)_____________reducing the interest of the loan. Prepayment risk can be determined by many factors, such as the current and issued mortgage rate difference, housing turnover and path of mortgage rate. If the current mortgage rate is lower than the rate when the mortgage was issued or housing turnover is high, it will lead to higher prepayment risk. The path of the mortgage rate might be difficult to understand, so we will explain with an example. A mortgage pool begins with a mortgage rate of 9%, then 9)__________to 4%, rises to 10% and finally falls to 5%. Most homeowners would refinance their mortgages the first time the rates dropped, if they are aware of the information and are capable of doing so. Therefore, when the mortgage rate falls again, refinancing and prepayment would be much lower compared to the first time. Prepayment risk is an important 10)_______________to consider in ABS and MBS. Therefore, to deal with prepayment risk, they have tranching structures, which help by distributing prepayment risk among tranches. Investors can choose which tranche to invest based on their own preferences and risk tolerance.