Stripped MBS

DEFINITION of 'Stripped MBS'

A trust comprised of mortgage-backed securities which are split into principal-only strips and interest-only strips. Stripped MBS derive their cash flows either from principal payments or interest payments on the underlying mortgages, unlike conventional MBS where cash flows are based on both principal and interest payments. Stripped MBS are very sensitive to interest rate changes.

BREAKING DOWN 'Stripped MBS'

There are some fundamental differences between principal-only strips and interest-only strips. Principal-only strips consist of a known dollar amount, but the payment timing is unknown. They are sold to investors at a discount - which is based on interest rates and prepayment speed - on face value. Interest-only strips generate high levels of cash flow in the earlier years and substantially lower cash flows in the latter years.

Because of their structure, interest rate changes have an opposite effect on principal-only and interest-only strips. Rising rates increases the discount rate applied to cash flows, reducing the price of principal only strips; but since rising rates reduce prepayment levels, making mortgages last longer, interest-only strips will rise in price. Likewise, when interest rates are falling, principal-only strips will rise, while interest-only strips will decline.

RELATED TERMS
  1. Futures Strip

    The sale or purchase of futures in sequential delivery months ...
  2. Servicing Strip

    A security created by the stream of cash flows that result from ...
  3. Treasury STRIPS

    An acronym for 'separate trading of registered interest and principal ...
  4. Interest Only (IO) Strips

    The interest portion of mortgage, Treasury or bond payments, ...
  5. Equity Stripping

    The process of reducing the overall equity in a property in order ...
  6. Interest-Only ARM

    An adjustable-rate mortgage (ARM) with an initial interest-only ...
Related Articles
  1. Bonds & Fixed Income

    Introduction To STRIPS

    STRIPS provide an alternative form of bond for fixed-income investors who need definite cash flows at specific times. Read the article to find out how.
  2. Bonds & Fixed Income

    What are Treasury STRIPS?

    STRIPS is an acronym that stands for Separate Trading of Registered Interest and Principal Securities.
  3. Professionals

    Treasury STRIPS

    FINRA Series 7 Online Study Guide Section 4
  4. Options & Futures

    Strip Options: A Market Neutral Bearish Strategy

    Strip Options are market neutral trading strategies with profit potential on either side price movement, with a "bearish" skew.
  5. Home & Auto

    Interest-Only ARMs

    There are plenty of ways to end up with a bad mortgage. The risks of these five should make every homebuyer think twice before signing.
  6. Credit & Loans

    Would You Save with an Interest-Only Mortgage?

    Sophisticated borrowers might want to consider one of these loans to keep their initial payments low, but they need to fully understand the risks.
  7. Professionals

    Government Bonds

    CFA Level 1 - Government Bonds. Learn the various types of U.S. Government issued treasury securities. Also covers on and off-the-run securities and how to strip a bond.
  8. Professionals

    Arbitrage-free Valuation Approach

    CFA Level 1 - Arbitrage-free Valuation Approach. Learn how investors can determine the price of bonds using arbitrage-free valuation. Also describes the actions for acting on an arbitrage.
  9. Home & Auto

    Interest-Only Mortgages

    There are plenty of ways to end up with a bad mortgage. The risks of these five should make every homebuyer think twice before signing.
  10. Professionals

    Mortgage-Backed Securities (MBS)

    CFA Level 1 - Mortgage-Backed Securities (MBS). Learn the process of creating and collateralizing mortgage-backed securities. Covers their expected cash flows and possible risks.
RELATED FAQS
  1. Is there any time I would want to have a zero-principal mortgage?

    As a general rule, entering a zero principal mortgage, or what is commonly referred to as an "interest-only mortgage", is ... Read Answer >>
  2. What is a stripped bond?

    The quick answer to this question is that a stripped bond is a bond that has had its main components broken up into a zero-coupon ... Read Answer >>
  3. Why do MBS (mortgage-backed securities) still exist if they created so much trouble ...

    Read several different arguments in favor of allowing the trade of mortgage-backed securities, even after the financial crisis ... Read Answer >>
  4. What are the best ways to invest in mortgage-backed securities (MBS)?

    Find out how you can start investing in real estate through mortgage-backed securities. Read Answer >>
  5. An IA’s client has a primary goal of tax reduction and a secondary goal of current ...

    a. Treasury STRIPS b. Growth stocks c. Fixed annuities d. Municipal bonds Answer: DFixed annuities, growth stocks and STRIPS ... Read Answer >>
  6. What is securitization?

    Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming ... Read Answer >>
Hot Definitions
  1. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  2. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  3. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  4. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  5. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  6. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
Trading Center