What is Scheduled principal payment risk. here? Which of the following is the least significant risk faced by a holder of a mortgage-backed security? A) Interest rate risk. B) Scheduled principal payment risk. C) Prepayment risk. D) Reinvestment risk. Your answer: A was incorrect. The correct answer was B) Scheduled principal payment risk. Interest rate risk, prepayment risk and reinvestment risk are all significant for mortgage-backed securities. There is no risk embedded in a scheduled principal payment.
It’s probably what it sounds like: the risk of the debtor not paying off the principal portion of her obligation on time.
Since A, C and D are definitely associated with mortgage-backed security. Answer should be B. I don’t find a direct way to come to this answer. - Dinesh S
the way i read that answer (“There is no risk embedded in a scheduled principal payment.” ) is that there is no such thing as scheduled prepayment risk.It is just a term somebody made up for this question
i agree with sv102307, i have never heard about scheduled principal payment risk. It should’ve been credit risk.
I think because since this is related to MBS…there is little risk that the homeowner will miss a payment because their house would be at risk (foreclosure). So since most people like living in their homes and not be homeless…they’re going to do whatever it takes to make those payments on time (most of the time). Therefore, thats the least significant risk faced by a MBS holder. Please correct me if I’m wrong.
Amtrak, take a peek at the current subprime mortgage market. Don’t forget there’s borrowers of varying credit quality who face different mortgage terms. While I don’t think anyone here’s disagreeing with you that people enjoy having a roof over their heads, there’s simply times when some folks can no longer service their mortgage obligations. There can be a great deal of uncertainty regarding the timing of cash flows related to mortgages and mortgage-backed securities. This is due to a myriad of reasons, including borrower credit quality, embedded call options, macroeconomic conditions and interest rates. This uncertainty partially explains the popularity of CMOs, PO- and IO strips, among other MBS that allow investors to narrow their exposure. At LII you’ll have an opportunity to examine the ways in which prepayment rates are estimated and more of the interesting assumptions surrounding MBS, CDOs and related instruments. As sv and maratikus said, B is a risk fabricated by the authors of the question. Good luck on your upcoming exam.
I definitely understand there are times people can’t service their obligations, thats what I implied by (most of the time). But I do appreciate your detailed response, and thanks for the luck!