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Answer: I is true but II is incorrect.
The correct answer is **D: Both are correct.** ### Explanation of Difference I (Pool Identity / Redelivery Risk) This difference is accurate. In an **MBS repo**, the transaction is a true secured loan against **specific collateral**. The repo seller (borrower) posts a particular mortgage pool today and receives **exactly the same pool** back at maturity, regardless of any changes in its characteristics. In contrast, a **dollar roll** uses **TBA (to-be-announced)** contracts. The "buyer of the roll" (the party effectively borrowing cash by selling the front-month TBA and buying the back-month TBA) delivers a specific pool into the front-month sale but receives **any eligible pool** that meets the TBA specifications in the later month. The counterparty has the cheapest-to-deliver (CTD) option, so the returned collateral is **similar but not identical**. This introduces **redelivery risk** (or substitution risk) absent in a standard repo. ### Explanation of Difference II (Payments and Prepayment Exposure) This difference is also accurate. In a repo, the repo seller (who posted the pool as collateral) retains **economic ownership** during the term. They receive all **interest and scheduled principal payments** (and bear any **prepayment risk**) that occur over the financing period. In a dollar roll, the party delivering the pool into the front-month TBA **transfers ownership** for that month. They do **not** receive the payments (interest or principal, including prepayments) for the roll period. The back-month TBA purchase brings a new (or different) pool, with its own payment schedule starting afterward. TBA pricing incorporates the expected timing of payments via the "price drop" or implied financing rate, so the roll buyer is not systematically disadvantaged in expected value. However, the **risk profiles differ**: - The repo seller retains **prepayment risk exposure** (actual prepayments higher or lower than market-implied levels affect the value of the specific pool they get back). - The dollar roll participant does **not** have that exposure during the roll month, as they have effectively stepped out of ownership. This makes the transactions economically close but not identical in risk. ### Why Not the Other Choices? - **A (Neither correct)**: Both statements align with standard market conventions and FRM curriculum descriptions of dollar rolls vs. repos. - **B (Only I correct)**: II is also correct—the payment/prepayment risk distinction is a well-documented feature. - **C (Only II correct)**: I is also correct—the lack of identical pool redelivery is the defining structural difference between dollar rolls (TBA-based) and specific-collateral repos. Dollar rolls are popular for MBS financing precisely because they offer flexibility (no identical pool requirement) and often cheaper implied financing than repo, but at the cost of these two risk differences. In FRM Part I (Financial Markets and Products), this distinction highlights how TBA mechanics create unique risks compared to traditional repo.
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Author: LeetQuiz .
Consider an investor who wants to finance the purchase of a mortgage pool over a one month period. One alternative is to sell an MBS repo, in which case the investor could sell the pool today while simultaneously agreeing to repurchase it after a month. This trade has the same economics as a secured loan: the investor effectively borrows cash today by posting the pool as collateral, and upon paying back the loan with interest after a month, retrieves the collateral. An alternative is the “dollar roll”. In the dollar roll, the buyer of the roll sells a TBA for one settlement month (the “earlier month”) and buys the same TBA for the following settlement month (the “later month”). For example, the investor who just purchased a 30-year 4% FNMA pool might sell the FNMA 30-year 4% January TBA and buy the FNMA 30-year 4% February TBA. Delivering the pool just purchased through the sale of the January TBA, which raises cash, and purchasing a pool through the February TBA, which returns cash, is very close to the economics of a secured loan. But there are two important differences between dollar roll and repo financing: I. The buyer of the roll may not get back in the later month the same pool delivered in the earlier month. The buyer of the roll delivers a particular pool, for example, in January but will have to accept whatever eligible pool is delivered in the next February. By contrast, an MBS repo seller is always returned the same pool that was originally posted as collateral. II. The buyer of the roll does not receive any interest or principal payments from the pool over the roll. For example, the buyer of the Jan/Feb roll, who delivers the pool in January, does not receive the January payments of interest and principal. By contrast, a repo seller receives any payments of interest and principal over the life of the repo. While the prices of TBA contracts reflect the timing of payments, so that the buyer of a roll does not, in any sense, lose a month of payments relative to a repo seller, the risks of the two transactions are different. The buyer of a roll does not have any exposure to prepayments over the month being higher or lower than what had been implied by TBA prices while the repo seller does. Which of these two differences is (are) correct?
A
Neither is correct.
B
I is true but II is incorrect.
C
I is incorrect but II is true.
D
Both are correct.