DOC-20250108-WA0000_250108_031157.PDF

Here are 10 multiple-choice questions (MCQs) based on the provided text, tailored to the CFA Level 1 exam difficulty and relevance: #MBS : Reading 67 --- 1. What type of risk do MBS investors face when prepayments occur slower than expected? A. Contraction risk B. Extension risk C. Interest rate...

Here are 10 multiple-choice questions (MCQs) based on the provided text, tailored to the CFA Level 1 exam difficulty and relevance: #MBS : Reading 67 --- 1. What type of risk do MBS investors face when prepayments occur slower than expected? A. Contraction risk B. Extension risk C. Interest rate risk D. Prepayment penalty risk Answer: B. Extension risk Explanation: Extension risk arises when prepayments are slower than expected, delaying cash flows to investors. --- 2. Which factor primarily drives the speed of mortgage prepayments? A. Borrower’s credit score B. Interest rate environment C. Loan-to-value ratio D. Debt-to-income ratio Answer: B. Interest rate environment Explanation: Prepayment speeds increase when interest rates decrease as borrowers refinance mortgages. --- 3. What happens to the prices of MBS when interest rates decrease? A. Prices rise faster than other fixed-income securities B. Prices remain unchanged C. Prices rise slower due to embedded prepayment options D. Prices fall due to reduced refinancing Answer: C. Prices rise slower due to embedded prepayment options Explanation: Embedded prepayment options in MBS cause negative convexity, limiting price appreciation in low-rate environments. --- 4. What is the primary purpose of time tranching in MBS structures? A. Eliminate prepayment risk B. Reduce administrative fees C. Redistribute contraction and extension risks D. Minimize interest rate risk Answer: C. Redistribute contraction and extension risks Explanation: Time tranching redistributes prepayment risks among different bond classes. --- 5. In the United States, mortgages with low LTV and DTI ratios are classified as: A. Non-agency loans B. Prime loans C. Subprime loans D. Nonrecourse loans Answer: B. Prime loans Explanation: Prime loans have lower risk characteristics, including low LTV and DTI ratios. --- 6. What is a unique feature of non-agency RMBS compared to agency RMBS? A. Government guarantee B. GSE guarantee C. Inclusion of credit enhancements D. Guaranteed prepayment rates Answer: C. Inclusion of credit enhancements Explanation: Non-agency RMBS include credit enhancements as they lack government or GSE guarantees. --- 7. A borrower defaults on a nonrecourse mortgage. What is the lender’s claim? A. The borrower’s personal assets and the collateral property B. The collateral property only C. A reduced claim based on foreclosure proceeds D. No claim Answer: B. The collateral property only Explanation: Nonrecourse loans limit the lender’s claim to the specified collateral. --- 8. Which of the following best describes a collateralized mortgage obligation (CMO)? A. A single class of bonds backed by mortgage pools B. A structured security with tranches to redistribute prepayment risk C. A mortgage-backed security with fixed reinvestment rates D. A pass-through security with no prepayment risk Answer: B. A structured security with tranches to redistribute prepayment risk Explanation: CMOs divide cash flows into tranches to match investors’ risk preferences. --- 9. What does a weighted average maturity (WAM) represent in a pool of mortgages? A. The average interest rate of all mortgages in the pool B. The average time to maturity weighted by principal balances C. The average prepayment rate of the mortgage pool D. The average servicing fee for securitized mortgages Answer: B. The average time to maturity weighted by principal balances Explanation: WAM calculates the weighted maturity of all mortgages based on their principal balances. --- 10. In a sequential pay CMO structure, what happens to principal repayments? A. They are distributed proportionally to all tranches B. They are allocated to the tranche with the shortest maturity first C. They are paid to the tranche with the longest maturity first D. They are evenly split across all tranches Answer: B. They are allocated to the tranche with the shortest maturity first Explanation: Sequential pay CMOs prioritize principal repayments to tranches in a specified order. 1. What is prepayment risk in mortgage-backed securities (MBSs)? a. The risk of default on the underlying mortgages b. The risk of unexpected changes in prepayment speeds c. The risk of changes in interest rates d. The risk of credit downgrades of the MBS Answer: b Explanation: Prepayment risk refers to the risk that prepayment speeds differ from investors' expectations, impacting cash flows. --- 2. What is the impact of extension risk on MBS investors? a. Investors receive cash flows sooner than expected b. Investors face reinvestment risk in a low-rate environment c. Investors wait longer for cash flows, discounted at a higher rate d. Investors benefit from stable cash flows Answer: c Explanation: Extension risk causes investors to wait longer for cash flows, which are discounted more heavily due to higher interest rates. --- 3. How do falling interest rates affect prepayment speeds? a. Prepayment speeds increase, leading to contraction risk b. Prepayment speeds decrease, leading to extension risk c. Prepayment speeds remain unchanged d. Prepayment speeds decrease, leading to stable cash flows Answer: a Explanation: Falling interest rates incentivize borrowers to refinance, increasing prepayments and causing contraction risk. --- 4. What is the primary similarity between MBSs and callable bonds? a. Both provide guaranteed cash flows b. Both offer protection against interest rate risk c. Both have negative convexity at low yields d. Both are not affected by prepayment Answer: c Explanation: MBSs, like callable bonds, exhibit negative convexity because their prices rise slower as yields fall due to prepayment options. --- 5. Which type of mortgage loan feature is common in Europe but rare in the United States? a. Prepayment penalties b. Nonrecourse loans c. Sequential pay structures d. Floating-rate mortgages Answer: a Explanation: Prepayment penalties are designed to reduce prepayment risk and are more common in Europe. --- 6. In a nonrecourse loan, what happens when the borrower defaults? a. The lender has no claim beyond the collateral property b. The lender can seize all borrower assets c. The borrower pays a penalty fee d. The borrower must refinance the loan Answer: a Explanation: In a nonrecourse loan, the lender can only claim the property used as collateral in the event of default. --- 7. What is the loan-to-value (LTV) ratio for a $250,000 mortgage on a $400,000 property? a. 62.5% b. 75% c. 50% d. 125% Answer: a Explanation: LTV is calculated as $250,000 / $400,000 = 62.5%, representing the percentage of the property value financed by the loan. --- 8. Which type of MBS is guaranteed by a government-sponsored enterprise (GSE) in the United States? a. Non-agency RMBS b. Agency RMBS c. Subprime RMBS d. Collateralized RMBS Answer: b Explanation: Agency RMBS are guaranteed by GSEs or the government, providing more security to investors. --- 9. What is the primary purpose of tranching in CMOs? a. To reduce prepayment risk b. To allocate prepayment risk among different tranches c. To eliminate default risk d. To stabilize cash flows Answer: b Explanation: Tranching redistributes prepayment risks (contraction and extension risks) among different investor classes. --- 10. In a sequential pay CMO, which tranche receives principal payments first? a. The tranche with the lowest interest rate b. The tranche with the longest maturity c. The first tranche in the sequence d. The tranche with the highest yield Answer: c Explanation: Sequential pay CMOs allocate principal payments to the first tranche until it is fully paid off, then to the next. 1. What does the weighted-average life (WAL) of an MBS represent? a. The average maturity of all underlying mortgages b. The time it takes for half the principal to be repaid c. The time-weighted average of expected cash flows d. The maturity date of the longest loan in the pool Answer: c Explanation: WAL measures the average time-weighted period until the principal is repaid, accounting for prepayments. --- 2. How does negative convexity affect the price-yield relationship of MBSs? a. MBS prices rise more than expected as yields fall b. MBS prices fall more than expected as yields rise c. MBS prices rise less than expected as yields fall d. MBS prices remain unaffected by yield changes Answer: c Explanation: Negative convexity in MBSs leads to smaller price increases when yields fall due to prepayment risk. --- 3. Which type of prepayment model assumes prepayment rates increase with loan age and then level off? a. PSA prepayment model b. CPR model c. Conditional Default Rate (CDR) model d. Static prepayment model Answer: a Explanation: The PSA model assumes prepayments start slow, increase with seasoning, and stabilize after 30 months. --- 4. What does CPR (Conditional Prepayment Rate) measure in MBSs? a. Annualized rate of defaults in a pool b. Monthly probability of prepayment for a loan c. Annualized percentage of the remaining loan pool prepaid d. The cumulative prepayment rate over a loan’s life Answer: c Explanation: CPR is the annualized percentage of the remaining mortgage balance that is expected to prepay. --- 5. Which factor most directly increases contraction risk in MBSs? a. Rising interest rates b. Falling interest rates c. Economic downturns d. Credit quality deterioration Answer: b Explanation: Falling interest rates encourage refinancing, leading to higher prepayment rates and contraction risk. --- 6. What is the primary benefit of investing in agency RMBS? a. Higher returns compared to non-agency RMBS b. Protection against prepayment risk c. Guarantee of principal and interest payments by a GSE d. Insulation from interest rate risk Answer: c Explanation: Agency RMBS are guaranteed by GSEs, providing investors with principal and interest payment protection. --- 7. Which type of mortgage-backed security (MBS) has no prepayment protection? a. Pass-through securities b. Planned Amortization Class (PAC) tranches c. Support tranches d. Sequential-pay CMOs Answer: a Explanation: Pass-through securities pass prepayment risk directly to investors without any structural protection. --- 8. What is a planned amortization class (PAC) tranche in CMOs designed to do? a. Maximize investor yield b. Provide stable cash flows by mitigating prepayment variability c. Increase the speed of principal repayments d. Allocate default risk among other tranches Answer: b Explanation: PAC tranches provide predictable cash flows by absorbing variability in prepayments through companion tranches. --- 9. What is the key distinction between agency RMBS and non-agency RMBS? a. Agency RMBS have higher yields than non-agency RMBS b. Agency RMBS are backed by the government, non-agency are not c. Non-agency RMBS have no prepayment risk d. Agency RMBS carry more credit risk Answer: b Explanation: Agency RMBS are backed by government entities or GSEs, while non-agency RMBS lack such guarantees. --- 10. What is the primary purpose of a credit enhancement in non-agency MBS? a. To reduce interest rate risk b. To mitigate the risk of borrower defaults c. To protect against prepayment risk d. To improve the predictability of cash flows Answer: b Explanation: Credit enhancements, such as reserve funds or subordination, are used to mitigate default risk in non-agency MBS. 1. What does the weighted-average life (WAL) of an MBS represent? a. The average maturity of all underlying mortgages b. The time it takes for half the principal to be repaid c. The time-weighted average of expected cash flows d. The maturity date of the longest loan in the pool Answer: c Explanation: WAL measures the average time-weighted period until the principal is repaid, accounting for prepayments. --- 2. How does negative convexity affect the price-yield relationship of MBSs? a. MBS prices rise more than expected as yields fall b. MBS prices fall more than expected as yields rise c. MBS prices rise less than expected as yields fall d. MBS prices remain unaffected by yield changes Answer: c Explanation: Negative convexity in MBSs leads to smaller price increases when yields fall due to prepayment risk. --- 3. Which type of prepayment model assumes prepayment rates increase with loan age and then level off? a. PSA prepayment model b. CPR model c. Conditional Default Rate (CDR) model d. Static prepayment model Answer: a Explanation: The PSA model assumes prepayments start slow, increase with seasoning, and stabilize after 30 months. --- 4. What does CPR (Conditional Prepayment Rate) measure in MBSs? a. Annualized rate of defaults in a pool b. Monthly probability of prepayment for a loan c. Annualized percentage of the remaining loan pool prepaid d. The cumulative prepayment rate over a loan’s life Answer: c Explanation: CPR is the annualized percentage of the remaining mortgage balance that is expected to prepay. --- 5. Which factor most directly increases contraction risk in MBSs? a. Rising interest rates b. Falling interest rates c. Economic downturns d. Credit quality deterioration Answer: b Explanation: Falling interest rates encourage refinancing, leading to higher prepayment rates and contraction risk. --- 6. What is the primary benefit of investing in agency RMBS? a. Higher returns compared to non-agency RMBS b. Protection against prepayment risk c. Guarantee of principal and interest payments by a GSE d. Insulation from interest rate risk Answer: c Explanation: Agency RMBS are guaranteed by GSEs, providing investors with principal and interest payment protection. --- 7. Which type of mortgage-backed security (MBS) has no prepayment protection? a. Pass-through securities b. Planned Amortization Class (PAC) tranches c. Support tranches d. Sequential-pay CMOs Answer: a Explanation: Pass-through securities pass prepayment risk directly to investors without any structural protection. --- 8. What is a planned amortization class (PAC) tranche in CMOs designed to do? a. Maximize investor yield b. Provide stable cash flows by mitigating prepayment variability c. Increase the speed of principal repayments d. Allocate default risk among other tranches Answer: b Explanation: PAC tranches provide predictable cash flows by absorbing variability in prepayments through companion tranches. --- 9. What is the key distinction between agency RMBS and non-agency RMBS? a. Agency RMBS have higher yields than non-agency RMBS b. Agency RMBS are backed by the government, non-agency are not c. Non-agency RMBS have no prepayment risk d. Agency RMBS carry more credit risk Answer: b Explanation: Agency RMBS are backed by government entities or GSEs, while non-agency RMBS lack such guarantees. --- 10. What is the primary purpose of a credit enhancement in non-agency MBS? a. To reduce interest rate risk b. To mitigate the risk of borrower defaults c. To protect against prepayment risk d. To improve the predictability of cash flows Answer: b Explanation: Credit enhancements, such as reserve funds or subordination, are used to mitigate default risk in non-agency MBS. #Business_Structure :: Reading #22 Here are 10 multiple-choice questions (MCQs) based on the provided text from the CFA Level 1 curriculum, along with their answers and brief explanations. --- MCQ 1 Which of the following statements about sole proprietorships is correct? A. Profits are subject to double taxation. B. Owners have limited liability for business debts. C. The business is a separate legal entity from the owner. D. The owner's personal income is taxed on profits. Answer: D Explanation: In a sole proprietorship, profits are taxed as personal income of the owner. --- MCQ 2 Which business structure features limited liability for some owners but unlimited liability for others? A. Sole proprietorship B. General partnership C. Limited partnership D. Corporation Answer: C Explanation: In a limited partnership, general partners have unlimited liability, while limited partners have liability limited to their investment. --- MCQ 3 What is a key disadvantage of the corporate business structure? A. Limited access to additional capital B. Separation of ownership and management C. Double taxation of profits D. Unlimited liability of owners Answer: C Explanation: Corporations may face double taxation—once on corporate earnings and again on dividends paid to shareholders. --- MCQ 4 Which of the following is true of a general partnership? A. Partners are taxed separately from the partnership. B. Liability of each partner is limited to their investment. C. A written partnership agreement is mandatory. D. Partners have unlimited liability for claims against the business. Answer: D Explanation: In a general partnership, all partners share unlimited liability for the debts and obligations of the business. --- MCQ 5 Which of the following is a distinguishing feature of a corporation? A. Owners are directly involved in day-to-day operations. B. Shareholders are personally liable for the company's debts. C. It is a separate legal entity from its owners. D. It does not pay corporate taxes. Answer: C Explanation: A corporation is a legal entity separate from its owners and managers. --- MCQ 6 Which organizational form typically has fewer regulatory requirements? A. Public corporation B. Private limited company C. Sole proprietorship D. Limited partnership Answer: B Explanation: Private limited companies have fewer regulatory and disclosure requirements compared to public corporations. --- MCQ 7 In a direct listing, the private company: A. Raises capital through an IPO. B. Sells new shares to investors. C. Lists existing shares on an exchange. D. Partners with a SPAC to go public. Answer: C Explanation: In a direct listing, a company's existing shares are listed on an exchange without raising new capital. --- MCQ 8 What is the primary function of the board of directors in a corporation? A. Manage the company’s daily operations. B. Elect the company’s shareholders. C. Act in the interests of the shareholders. D. Handle all financial reporting requirements. Answer: C Explanation: The board of directors is responsible for acting in the best interests of the shareholders. --- MCQ 9 What is a distinguishing characteristic of limited liability partnerships (LLPs)? A. They require at least one general partner. B. All partners have limited liability. C. They are not allowed in the United States. D. They are primarily used for public corporations. Answer: B Explanation: In an LLP, all partners enjoy limited liability. --- MCQ 10 What is the effective tax rate if a corporation with pretax earnings of $10 million, taxed at 25%, pays out 100% of its profits as dividends and shareholders are taxed at 20%? A. 20% B. 25% C. 40% D. 45% Answer: D Explanation: The effective tax rate is calculated as follows: Corporate tax = $10M × 25% = $2.5M → $7.5M remains. Shareholder tax = $7.5M × 20% = $1.5M. Effective tax = ($2.5M + $1.5M) ÷ $10M = 40%. Additional 10 MCQs for CFA Level 1 - Module 22.1 (Features of Corporate Issuers) --- 1. Which of the following is true for a sole proprietorship? A. Profits are taxed at the corporate level. B. Liability for claims is limited to the owner's investment. C. The owner is personally responsible for all claims. D. It provides significant access to external capital. Answer: C Explanation: In a sole proprietorship, the owner has unlimited liability and is personally responsible for claims. --- 2. A limited partnership differs from a general partnership because: A. It requires an equal number of general and limited partners. B. Limited partners have voting rights over business operations. C. General partners have unlimited liability, while limited partners have liability capped at their investment. D. It allows limited partners to manage the business actively. Answer: C Explanation: Limited partners have liability limited to their investment, while general partners have unlimited liability and operational responsibilities. --- 3. Which organizational form offers the best access to additional capital? A. Sole proprietorship B. General partnership C. Corporation D. Limited partnership Answer: C Explanation: Corporations have the greatest access to capital due to their ability to issue shares and raise equity or debt financing. --- 4. A corporation's owners typically influence operations through: A. Direct daily management. B. Appointment of the board of directors. C. Approval of management decisions. D. Voting on all operational issues. Answer: B Explanation: Shareholders of a corporation elect a board of directors, which is responsible for hiring senior management to run operations. --- 5. Which of the following is a characteristic of private limited companies? A. Shares are freely traded on exchanges. B. They face fewer regulatory requirements than public companies. C. They must disclose quarterly financial reports. D. Investors can easily observe the market value of shares. Answer: B Explanation: Private limited companies face fewer regulatory requirements and disclose less information compared to public companies. --- 6. Double taxation in corporations refers to: A. Taxing the same income in multiple countries. B. Taxing corporate earnings and dividends separately. C. Taxing profits twice within the corporation. D. Taxing shareholders on reinvested earnings. Answer: B Explanation: Double taxation occurs when corporate profits are taxed, and dividends distributed to shareholders are taxed as personal income. --- 7. What is the primary feature of an LLP (Limited Liability Partnership)? A. It does not require a general partner. B. All partners have unlimited liability. C. It is restricted to certain industries in the U.S. D. Limited partners actively manage the business. Answer: A Explanation: An LLP allows all partners to have limited liability without requiring a general partner. --- 8. Which statement is correct regarding SPACs (Special Purpose Acquisition Companies)? A. They raise funds without a specific acquisition target at the time of the IPO. B. They are used only for restructuring underperforming public companies. C. They involve direct listings of shares. D. They must identify the target company before the IPO. Answer: A Explanation: SPACs are "blank check" companies that raise funds via IPOs without identifying an acquisition target initially. --- 9. A direct listing differs from an IPO in that: A. It raises new capital for the company. B. It requires an underwriter. C. It does not involve issuing new shares. D. It takes longer to complete than an IPO. Answer: C Explanation: A direct listing involves listing existing shares on an exchange without issuing new shares or raising additional capital. --- 10. Which type of corporate issuer typically has shares with the highest free float? A. Private limited companies B. Public limited companies C. Sole proprietorships D. Limited partnerships Answer: B Explanation: Public limited companies have shares that trade freely on stock exchanges, resulting in a higher free float. Additional 10 CFA Level 1 MCQs - Corporate Issuers --- 1. Which of the following is an advantage of a general partnership over a sole proprietorship? A. Limited liability for all partners. B. Access to more capital resources. C. No risk of profit-sharing. D. Exemption from personal liability. Answer: B Explanation: General partnerships provide access to more capital as there are multiple partners contributing resources. --- 2. A distinguishing feature of a C corporation compared to an S corporation is: A. The ability to avoid double taxation. B. A restriction on the number of shareholders. C. The ability to raise capital through public markets. D. Liability limited only to specific shareholders. Answer: C Explanation: C corporations can raise capital through public markets, whereas S corporations are limited to private ownership and fewer shareholders. --- 3. In a publicly traded company, the principal-agent problem arises because: A. Shareholders directly manage day-to-day operations. B. Managers' interests may not align with shareholders' goals. C. Shareholders appoint auditors for operational decisions. D. Managers own the majority of shares. Answer: B Explanation: The principal-agent problem arises when managers (agents) prioritize personal interests over shareholders' (principals) objectives. --- 4. The primary purpose of a corporate charter is to: A. Outline a company's day-to-day operations. B. Define the company's objectives and governance structure. C. Provide a list of the company’s shareholders. D. Determine annual dividend payments. Answer: B Explanation: A corporate charter defines the company's objectives, governance structure, and operational framework. --- 5. Which of the following is a key benefit of going public through an IPO? A. Full ownership control remains with the founders. B. Reduced regulatory compliance requirements. C. Enhanced liquidity for shareholders. D. Elimination of reporting to shareholders. Answer: C Explanation: An IPO enhances liquidity by allowing shares to be traded publicly on an exchange. --- 6. A corporate issuer chooses a dual-class share structure to: A. Equalize voting rights among all shareholders. B. Concentrate voting power with a specific group. C. Simplify ownership reporting requirements. D. Restrict trading of its shares in secondary markets. Answer: B Explanation: Dual-class share structures allow founders or specific groups to retain control by concentrating voting power in one class of shares. --- 7. Which of the following is an essential feature of private equity ownership? A. Public trading of shares. B. High levels of regulatory oversight. C. Long-term investment focus. D. Frequent share price disclosure. Answer: C Explanation: Private equity ownership involves a long-term investment focus, often aimed at enhancing company value before an eventual exit. --- 8. What is the primary objective of corporate governance? A. To maximize short-term profits for shareholders. B. To ensure ethical and transparent decision-making. C. To eliminate financial risks entirely. D. To minimize taxation for the corporation. Answer: B Explanation: Corporate governance ensures ethical, transparent decision-making that aligns with shareholders' interests and corporate goals. --- 9. Which of the following would most likely reduce conflicts of interest between shareholders and managers? A. Issuing additional shares to the public. B. Linking executive compensation to the company's performance. C. Limiting the board of directors to internal executives. D. Restricting voting rights of minority shareholders. Answer: B Explanation: Linking executive compensation to company performance aligns managers' interests with those of shareholders. 10. Which of the following is a disadvantage of a corporation compared to a partnership? A. Limited access to external capital. B. Unlimited liability for owners. C. Higher regulatory and compliance requirements. D. Lack of continuity in business operations. Answer: C Explanation: Corporations face higher regulatory and compliance requirements compared to partnerships, making them more complex to manage.