Stripped MBS (SMBS)
What Is a Stripped MBS (SMBS)?
A stripped mortgage-backed security (SMBS) is a type of mortgage-backed security created by separating the cash flows from a pool of mortgages into different parts, usually interest payments and principal payments. These separate pieces are then sold as distinct investments.
SMBS products are designed to appeal to investors with different income and risk preferences.
Why It Matters
Stripped MBS products are more complex than traditional bonds or standard mortgage-backed securities. They can offer potentially attractive returns, but they also involve unique risks, especially sensitivity to interest rates and mortgage prepayments.
Understanding SMBS helps investors recognize that not all fixed-income investments behave the same way.
How Stripped MBS Works
A pool of mortgage payments is divided into separate cash flow streams.
These streams may include:
- an interest-only (IO) portion
- a principal-only (PO) portion
The value of each portion depends on how quickly borrowers repay their mortgages. Changes in interest rates can significantly affect expected returns.
Example
An investor buying the interest-only portion of a stripped MBS may benefit when mortgage borrowers repay more slowly, allowing more interest payments over time.
Stripped MBS vs Traditional Mortgage-Backed Security
- A stripped MBS separates mortgage cash flows into parts.
- A traditional mortgage-backed security passes through combined principal and interest payments together.
FAQs About Stripped MBS
Why are stripped MBS considered risky?
They are highly sensitive to interest rates and mortgage prepayment speeds.
What does SMBS stand for?
It stands for stripped mortgage-backed security.
Are stripped MBS suitable for beginners?
They are generally considered more advanced fixed-income investments.
Related Terms
