Mortgage-Backed Securities
Bonds backed by a portfolio, or pool, of home mortgages.  The three issuers of mortgage-backed securities are the Government National Mortgage Association (GNMA), the Federal National Mortgage Association (FNMA), and the Federal Home Loan Mortgage Corporation (FHLMC).  Not to be confused with fixed maturity agency debt, mortgage-backed securities, commonly called pass-throughs, add a wrinkle to the analysis of a bond's potential yield and maturity date.  Instead of paying like a normal bond - a coupon payment every 6 months and a return of principal at maturity - mortgages "pass-through" both principal and interest on a monthly basis as principal and interest payments are paid by the owners of the mortgage loans in the pool.  As mortgage loans are paid off throughout the life of the mortgage-backed security, the full principal amount is passed through to investors and they receive an early payment of principal, called a prepayment.  Some general characteristics of mortgage-backed securities include:
  1. Mortgages pay the investor both principal and interest on a monthly basis, resulting in an average life that is much shorter than the stated maturity date.
  2. Although the coupon rate remains the same, the principal payment amount will adjust monthly depending on the number of prepayments of principal that take place in the pool.
  3. Principal payments increase as interest rates decrease and vice versa due to changes in the attractiveness of refinancing rates.