A mortgage-backed security (MBS) is a type of asset-backed security that is secured by a pool of mortgages. MBSs are typically issued by financial institutions, such as banks and mortgage companies.
MBSs work by pooling together a number of mortgages and then issuing securities that represent ownership interests in the pool. The securities are typically divided into tranches, with each tranche having a different level of risk. The most senior tranches have the lowest risk, as they are the first to receive payments from the pool of mortgages. The most junior tranches have the highest risk, as they are the last to receive payments from the pool of mortgages.
MBSs are a popular investment for a number of reasons. First, they offer investors the opportunity to earn a higher yield than they would typically earn from a traditional bond. Second, MBSs are relatively liquid, meaning that they can be easily bought and sold. Third, MBSs are backed by mortgages, which are considered to be relatively safe assets.
There are a number of different types of MBSs, each with its own unique features. Some of the most common types of MBSs include:
- Pass-through MBS: A pass-through MBS is a type of MBS where the investor receives payments that are directly passed through from the pool of mortgages.
- Structured MBS: A structured MBS is a type of MBS where the payments to the investor are structured in a specific way. For example, a structured MBS may pay out a fixed rate of interest for a certain period of time, and then switch to paying out a variable rate of interest.
- Collateralised mortgage obligation: A collateralised mortgage obligation (CMO) is a type of structured MBS that is divided into tranches with different levels of risk.
MBSs are a valuable tool for securitisation transactions. They can help to:
- Raise capital: MBSs can be used by financial institutions to raise capital. This can be helpful for financial institutions that are looking to expand their lending activities.
- Diversify risk: MBSs can help to diversify risk for investors. This is because the payments from the pool of mortgages are spread out over a number of different borrowers.
- Liquidity: MBSs can help to improve liquidity in the mortgage market. This is because they make it easier for investors to buy and sell mortgage-backed securities.
Overall, MBSs are a valuable tool for securitisation transactions. They can help to raise capital, diversify risk, and improve liquidity.