Agency mbs

Definition

Agency mortgage-backed securities (MBS) are debt securities created by pooling together mortgage loans, which are guaranteed by government-sponsored enterprises (GSEs) like Fannie Mae, Freddie Mac, and Ginnie Mae. These securities provide investors with a way to earn interest income while having a degree of safety due to the backing by GSEs, making them a popular choice in the fixed-income market.

5 Must Know Facts For Your Next Test

1. Agency MBS typically have lower yields compared to non-agency MBS due to the guarantee provided by GSEs, which lowers the perceived risk for investors.
2. They are highly liquid and can be easily bought or sold in secondary markets, making them attractive for institutional investors.
3. The cash flows from agency MBS are derived from monthly mortgage payments made by homeowners, including both principal and interest.
4. Investors in agency MBS are usually less exposed to credit risk since GSEs offer guarantees against defaults on the underlying mortgages.
5. Interest rate changes can significantly affect the value of agency MBS, as they influence prepayment rates and investor returns.

Review Questions

• How do agency MBS provide safety for investors compared to other types of mortgage-backed securities?
  • Agency MBS are backed by government-sponsored enterprises like Fannie Mae and Freddie Mac, which provide guarantees against defaults. This backing reduces the credit risk associated with investing in these securities compared to non-agency MBS that lack such guarantees. As a result, investors are more likely to feel secure when investing in agency MBS, even though they may offer lower yields due to this perceived safety.
• Discuss the role of prepayment risk in agency MBS and how it affects investor returns.
  • Prepayment risk is a significant concern for agency MBS because homeowners can refinance or pay off their mortgages earlier than expected. This can lead to cash flow disruptions for investors, as they may receive their principal back sooner than anticipated, often at a time when interest rates are lower. Consequently, investors might reinvest their returns at less favorable rates, impacting overall investment performance and returns from agency MBS.
• Evaluate how changes in interest rates influence the market for agency MBS and what strategies investors might use to mitigate risks associated with these changes.
  • Interest rate fluctuations have a direct impact on the market for agency MBS, primarily affecting prepayment rates and the overall valuation of these securities. When interest rates rise, homeowners are less likely to refinance, which can reduce prepayment risk and potentially increase cash flows for investors. Conversely, if rates fall, increased refinancing may lead to higher prepayment rates. Investors may use strategies like duration matching or diversifying their portfolios across different maturities to mitigate risks linked to interest rate changes while still benefiting from the relative safety of agency MBS.

Related terms

Government-Sponsored Enterprises (GSEs): Financial services corporations created by Congress to enhance the flow of credit to specific sectors, notably housing, through mortgage guarantees and purchasing.

Mortgage-Backed Securities (MBS): Securities that are backed by a pool of mortgage loans, providing investors with returns based on the mortgage payments made by borrowers.

Prepayment Risk: The risk that homeowners will pay off their mortgages early, which can affect the cash flow and return of mortgage-backed securities.