An investor purchases $1 million of a mortgage-backed security. The periodic interest amount received on a mortgage-backed security: A) Increases over time B) Decreases over time C) Remains constant D) Cant remember I was under the impression that the actual payment received from the MBS would be fixed, even though the makeup of that payment changes in terms of % made up of principal and % made up of interest. The answer is B. Is that just because of prepayment?
But they’re asking about the interest component of the MBS and you’ve already answered it yourself by saying that “I was under the impression that the actual payment received from the MBS would be fixed, even though the makeup of that payment changes in terms of % made up of principal and % made up of interest.” So the answer B is correct. If they asked for the periodic payment amount, then it would be C.
It is the same concept as if you actually had a mortgage that you were paying. Your monthly payment stays the same for the entire term, but the amount of principle that is being paid off increases with time, and the interest paid decreases.
Actually, it’s the same principle that if you get paid for some finite amount of time and you have only choices “payment increases”, “payment decreases”, “payment stays the same” it must be payment decreases because ultimately it goes to 0.