1) Explain the difference between a bid price and an asked price and also explain why...

1) Explain the difference between a bid price and an asked price and also explain why the prices are different.

2) Explain what a mortgage-backed security (MBS) is and how it functions. Also, explain why these securities were such a problem during 2008.

3) What is the meaning of a pure discount or zero coupon debt instrument?

Solutions

Expert Solution

Bid price is the price at which buyer is willing to buy a security and Ask Price is the price at which the seller is willing to sell the security. There is a price difference between them because the buyer will always prefer to buy at low and the seller will always prefer to sell at high.
Mortgage backed security is a pool of various securities which are backed by mortgages. The interest payment received from the borrowers will be to used to pay for the MBS. MBS could comprise of multiple tranches of securities having different interest rates and rating level. These securities were a problem in 2008 as the banks started pooling subprime or riskier MBS and got them a higher rating. When the borrowers started to default on these subprime loans, the MBS investors started losing on their investment and gradually it created a housing bubble.
A discount bond is a bond which is issued at a price lower than the par value or face value.

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