1. Mortgage-Backed Securities (MBS): MBS or Mortgage-Backed Securities are financial instruments that are backed by a loan secured by a pool of mortgages, usually from various borrowers. The loans are sold by the lender and grouped into pools by the investor in an MBS who then receives regular payments of principal and interest.
2. Interest Rate Risk : MBS holders are exposed to interest rate risk, as changes in the interest rate will alter the cost of servicing the mortgages in the MBS pools, thus lowering the value of the MBS.
3. Investor Acquisitions: Investors can purchase MBS directly from the originator, or through a broker, or in a secondary market such as the over-the-counter (OTC) markets.
4. Prepayment Risk: When the interest rate drops, homeowners often choose to refinance their mortgages, which can lead to prepayment risk for MBS holders.
5. Credit Risk: Credit risk is inherent in all MBS due to the possibility that some mortgagors may default on their payments, thus adversely affecting the performance of the MBS.
6. Structured Products: Structured products refer to structured securities such as collateralized debt obligations (CDOs) and mortgage-related structured products (MRSPs). These products are created through complex financial engineering techniques and are designed to provide investors with exposure to a wide range of mortgage-related assets in one investment vehicle.
7. Regulatory Framework: MBS issuers must comply with a complex regulatory framework as established by the Securities and Exchange Commission (SEC), the Investment Company Act of 1940, the Commodity Futures Trading Commission (CFTC), the Federal Home Loan Bank Board (FHLBB), and other relevant regulatory bodies.