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Booyah Breakdown: MBS 101

The investors of these securities are typically very large and sophisticated money managers, like mutual funds and pension funds.

Why Not Just Buy a Bond?

One of the biggest reasons you invest in MBS is that your cash flow comes faster. Joe Borrower (supposedly) makes monthly payments - which come to you -- as opposed to a bond's interest payment, which is usually paid out semiannually.

There's also more risk than buying a Treasury bond. That's because Joe Borrower has the option to pay his mortgage off early -- maybe he wants to refinance the loan, relocate for a new job or just get nicer digs. That deprives you of future income and forces you to put your money to work somewhere else.

And in some cases, you're depending on Joe Borrower to make his payments.

That extra risk entitles you to more money. The interest rate on a 30-year Treasury bond these days is around 4.8% vs. a 30-year mortgage loan, which could be around 6% for the most creditworthy borrowers. So you get a higher yield with the MBS.

The easiest way to get information on these securities is to call any fund family like Fidelity, T. Rowe Price (TROW - Get Report) and Pimco. Or call the banks, like Bear Stearns (BSC)or Washington Mutual (WM - Get Report).

You could also consider the newly launched iShares Lehman MBS Fixed-Rate Bond Fund (MBB), a new ETF that provides exposure to mortgage-backed securities. Big note: There are no subprime mortgages in this product.

The Big Question: What's the Risk?

First, an important distinction. The mortgages backing the securities issued by Fannie and Freddie are guaranteed. So if Joe Borrower misses a payment, the housing agenices foot the bill.

But for the most part, the folks who invest in mortgage-backed securities issued by an investment bank are relying on our original Joe Borrower to make his mortgage payment.
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