Stripped Mortgage-Backed Securities

Cyrus Mohebbi, Raymond Yu, Marc Barakat and Paula Steisel Goldfarb

in The Handbook of Mortgage-Backed Securities

Published in print August 2016 | ISBN: 9780198785774
Published online October 2016 | e-ISBN: 9780191827594 | DOI:
Stripped Mortgage-Backed Securities

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This chapter examines stripped mortgage-backed securities (SMBS), a class that enables investors to take strong market positions on expected movements in prepayment and interest rates. SMBS are used both as hedges of prepayment and interest rate risk and as yield enhancement mechanisms. They are highly sensitive to changes in interest rate and prepayment speeds and tend to display asymmetric returns. SMBS certificates that are allocated all or large proportions of underlying principal cash flows tend to display very attractive bullish return profiles. As market rates drop and prepayments on the underlying collateral increase, the return of these SMBS will be greatly enhanced since principal cash flows will be returned earlier than expected. Conversely, SMBS that are entitled to all or a large percentage of the interest cash flows have very appealing bearish return characteristics since greater amounts of interest cash flows are generated when prepayments of principal decrease.

Keywords: stripped mortgage-backed securities; market positions; prepayment; interest rates; interest rate risk; yield enhancement mechanisms; SMBS certificates; principal

Chapter.  5470 words.  Illustrated.

Subjects: Financial Markets ; Macroeconomics and Monetary Economics

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