Finance & Real Estate Explain the essential difference when it comes to risk between a CMBS...

Finance & Real Estate

Explain the essential difference when it comes to risk between a CMBS and a MBS containing residential mortgages.

Expert Solution

CMBS is Commercial Mortgage Backed Security is a type of sixed income instrument which is backed by Commercial buildings lands etc. All the process and structure of a CMBS is similar to Residential Mortgage Backed security apart from its underlying security. A RMBS use residential houses as collateral whereas CMBS uses commercial plots.

Like any bond instrument there is risk of default for CMBS and if underlying borrower fails to make payment, the investor can experience a loss. Major risk of CMBS comes from the weakness of Real estate market and is prone to systematic risk just like RMBS in 2008.

CMBS offers a way for investing in real estate by low income group and people who cant afford otherwise. It has a strong underlying asset compared to RMBS but since CMBS is highly unregulated and are currently designed for wealthy investors the liquidity risk is high for such instruments.

RMBS has high level of prepayment risk whereas for CMBS since prepayment comes with a penalty the risk is much lower than RMBS. Also both RMBS and CMBS are negatively convexed securities.

jeff jeffy answered 2 years ago

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