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What are Mortgage-Backed Securities (MBS)?
Mortgage-Backed Securities (MBS) are financial instruments created by pooling together home loans and selling shares of the pool to investors. Investors receive periodic payments derived from the mortgage borrowers’ repayments.
Definition
An MBS is an asset-backed security secured by a collection of residential or commercial mortgages, where investors receive cash flows from the underlying loan payments.
Key Takeaways
- Formed from pools of mortgage loans.
- Provide investors with regular interest and principal payments.
- Issued by banks, financial institutions, or government-backed agencies.
Understanding Mortgage-Backed Securities
Banks originate mortgages and sell them to financial institutions, which package them into MBS. This process frees up capital for banks to issue more loans.
Investors in MBS receive monthly cash flows similar to bond coupon payments. However, these payments depend on mortgage holders’ repayment patterns, including prepayments.
Government-sponsored entities like Fannie Mae, Freddie Mac, and Ginnie Mae (in the U.S.) play major roles in the MBS market by guaranteeing or issuing certain types of securities.
Formula (If Applicable)
There is no single formula, but valuation models consider:
- Present value of expected cash flows
- Prepayment rates
- Interest rate movement
Basic bond pricing applies:
[ P = \sum \frac{CF_t}{(1+r)^t} ]
Where:
- ( CF_t ) = cash flow at time t
- ( r ) = discount rate
Real-World Example
A financial institution bundles 2,000 home loans into an MBS. Investors buy portions of the security and receive monthly payments funded by the mortgage holders’ repayments.
Importance in Business or Economics
MBS markets influence housing finance, bank liquidity, interest rates, and financial stability. While they help expand access to home loans, poorly regulated MBS contributed to the 2008 financial crisis.
Types or Variations
- Pass-Through MBS
- Collateralized Mortgage Obligations (CMOs)
- Commercial MBS (CMBS)
- Agency vs. Non-Agency MBS
Related Terms
- Asset-Backed Securities
- Securitization
- Prepayment Risk
Sources and Further Reading
- Investopedia – Mortgage-Backed Securities
- U.S. SEC – Asset-Backed Securities
- IMF – Financial Stability Reports
Quick Reference
- Asset-backed securities made from mortgage pools.
- Provide steady cash flows to investors.
- Key part of global financial markets.
Frequently Asked Questions (FAQs)
Are MBS safe investments?
Agency-backed MBS are generally safer; non-agency MBS carry more risk.
What risks do MBS investors face?
Prepayment risk, interest rate risk, and credit risk.
How do MBS affect the economy?
They expand mortgage lending but can amplify financial instability if poorly regulated.
