Future Business Leaders of America (FBLA) Securities and Investments Practice Test

What underlying assets back a mortgage-backed security?

1. Stocks of public companies

2. Certificates of deposit

3. A pool of mortgages

4. Corporate bonds

The correct answer is: A pool of mortgages

Mortgage-backed securities (MBS) are financial instruments that represent claims on the cash flows generated by a specific pool of mortgages. These securities are created by aggregating multiple individual mortgage loans, which are then packaged together and sold to investors. The income generated from the interest and principal payments made by borrowers on the underlying mortgages is what supports the MBS, providing investors with returns based on these cash flows. The choice of a pool of mortgages as the underlying asset is essential because it forms the basis of how mortgage-backed securities operate. The performance of these securities is directly tied to the ability of homeowners to make their mortgage payments. When many mortgages are pooled together, it also serves to diversify risk, as the default of one or a few loans can be offset by the performance of others in the pool. In contrast, stocks of public companies, certificates of deposit, and corporate bonds do not directly relate to mortgage-backed securities. Stocks represent ownership in a company, certificates of deposit are savings accounts with a fixed term and interest rate, and corporate bonds are debt securities issued by companies. These instruments reflect different types of investment risks and returns, and they aren't connected to the mortgage market in the same way that a pool of mortgages is. Therefore, the correct underlying asset