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Mortgage-backed Security

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A mortgage-backed security (MBS) is a security based upon a pool of underlying mortgage loans. For instance, 500 thirty year fixed rate mortgage loans of $200,000 each can be combined into a $100 million mortgage-backed security issue. The underlying loans are generally insured against non-payment. In the US, Fannie Mae and Freddie Mac are two leading mortgage insurers and creators of mortgage-backed security instruments. Given that each loan in the underlying pool that formed the mortgage-backed security is insured, the primary risk for the mortgage-backed security holder is that of prepayment. The market for mortgage-backed security trading is known as the secondary mortgage market. A special type of mortgage-backed security is the collateralized mortgage obligation, or CMO, which separates the cash flows into different slices called tranches, that are paid at different times to the holders of the various tranches.



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