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IBBC CAPITAL ACADEMY / 2027

Mortgage cash flows and prepayment asymmetry

Independent IBBC Capital draft content for self-study. Not affiliated with or endorsed by CFA Institute. New lessons await subject-matter review. No CFA designation or official PSM credit is awarded.

Learning goals

  • Explain mortgage mechanics using mechanisms and limitations.
  • Explain prepayment and tranches using mechanisms and limitations.
  • Explain residential versus commercial using mechanisms and limitations.

Draft · approximately 25 minutes, excluding further revision.

Mortgage mechanics

Mortgage loans specify amortization, rate resets, collateral and borrower remedies; payment schedules differ from a simple bond principal bullet.

A mortgage pass-through distributes pooled borrower cash after fees; principal timing depends on amortization, default and unscheduled prepayments.

Prepayment and tranches

Falling rates can accelerate refinancing and return principal when reinvestment yields are lower; this is contraction risk for the investor.

Rising rates can slow prepayments and extend exposure when prices are pressured; extension risk is the other side of borrower prepayment flexibility.

Residential versus commercial

CMO time tranches allocate principal timing; planned-amortization protection depends on support capacity and prepayment paths rather than a guarantee.

Commercial MBS rely on property income and may feature balloon refinancing, call protection and property concentration; residential assumptions cannot simply be transplanted.

Formula and assumptions

Ending mortgage balance=beginning−scheduled principal−prepayments−write-offs

Original applied case: Mortgage cash flows and prepayment asymmetry

  1. A simplified pool starts at 1,000, receives scheduled principal 20 and unscheduled prepayment 80.
  2. Ending principal=1,000−20−80=900 before defaults or new lending.
  3. The extra 80 changes investor timing; it is returned principal rather than 80 of investment profit.

Errors to catch

  • Do not assume: All mortgages repay no principal until maturity.
  • Do not assume: Pass-through principal timing is fixed regardless of prepayment.
  • Do not assume: Faster refinancing always raises investor reinvestment yields.

Original knowledge check

Answer every question before checking. Review explanations after submitting; retry starts a new attempt.

Sources and coverage status

These original lessons are drafts. Public outlines are used to check scope; the official learning-outcome text and proprietary question banks are not reproduced here. Follow the source for exam-year requirements and updates.