CHAPTER 13Mortgage‐Backed Securities

Patrick Byrne

The U.S. agency mortgage‐backed securities market is one of the largest and arguably the most difficult sector of the investment‐grade universe to analyze and understand. Since the issuers in the agency MBS market carry either an implicit or full guarantee of the U.S. Treasury, credit risk on these bonds is minimal. However, unlike other domestic fixed‐income instruments, the primary risk in MBS is the early redemption of the bond triggered by prepayment of the underlying mortgage pools. While the risks associated with investing in MBS can be quantified, seldom do these risk events transpire exactly as expected, since the investor is subject to the capricious behavior of homeowners. Successful investing in the mortgage‐backed securities market is thus as much an art as it is a science.

Retail buyers beware: The mortgage‐backed marketplace is not a friendly place for those not well versed in its nuances. MBS is primarily an institutional marketplace where sophisticated buyers come to reap the rewards on large blocks of securities via in‐depth analysis of these complex products. Traders often speak of “odd lots” as any block of bonds smaller than $5,000,000. Historically, price transparency was virtually nonexistent on many types of esoteric MBSs, and spreads on secondary issues can be exceedingly wide. In recent years, the Financial Industry Regulatory Authority (FINRA) and Interactive Data Corporation (IDC) have created a suite ...

Get The Capital Markets now with O’Reilly online learning.

O’Reilly members experience live online training, plus books, videos, and digital content from 200+ publishers.