Offbeat Offerings: Mortgage-Backed Securities
The current housing market decline, increasing mortgage defaults and the financial struggles at Fannie Mae and Freddie Mac have shined a spotlight on a particular fixed-income product that is often not particularly well-understood by individual investors—mortgage-backed securities.
What are these products?
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Mortgage-backed securities are bonds that are backed by a pool of home mortgages. Investors receive proportionate shares of the interest and principal generated by the underlying mortgages. Typically the timely payment of both interest and principal is guaranteed, even if the home-owner defaults, by either the U.S. government through the Government National Mortgage Association (Ginnie Mae), or by one of two government-sponsored organizations, the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Association (Freddie Mac). The securities tend to be traded in large denominations; individual investors typically invest in these products through mutual funds or exchange-traded funds.
Their primary advantage is higher yields than other fixed-income instruments of comparable stated maturity and credit risk. However, those higher yields reflect risks that are different from those of other high-quality fixed-income securities.
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