The effect of prepay- ments is that the amount and timing of the cash flows from a mortgage loan are not known with certainty. This risk is referred to as prepay- ment risk. This is true for all mortgage loans, not just fixed-rate, level- payment, fully amortized mortgages.   Balloon Mortgages In a balloon mortgage, the borrower is given long-term financing by the lender but at specified future dates the mortgage rate is renegotiated. Thus, the lender is providing long-term funds for what is effectively a short-term borrowing, how short depending on the frequency of the renegotiation period. Effectively it is a short-term balloon loan in which the lender agrees to provide financing for the remainder of the term of the mortgage if certain conditions are met. The balloon payment is the original amount borrowed less the amount amortized. Thus, in a bal- loon mortgage, the actual maturity is shorter than the stated maturity.   Adjustable-Rate Mortgages As the name implies, an adjustable-rate mortgage (ARM) has an adjustable or floating coupon instead of a fixed one. The coupon adjusts periodi- cally-monthly, semiannually, or annually. Some ARMs even have coupons that adjust every three years or five years. The coupon formula for an ARM is specified in terms of a reference rate plus a quoted margin. At origination, the mortgage usually has an initial rate for an initial period (teaser period) which is slightly below the rate specified by the coupon formula. This is called a "teaser rate" and makes it easier for first time home buyers to qualify for the loan. At the end of the teaser period, the loan rate is reset based on the coupon formula. Once the loan comes out of its teaser period and resets based on the coupon for- mula, it is said to be fully indexed. To protect the homeowner from interest rate shock, there are caps imposed on the coupon adjustment level. There are periodic caps and life- time caps. The periodic cap limits the amount of coupon reset upward from one reset date to another. The lifetime cap is the maximum absolute level for the coupon rate that the loan can reset to for the life of the mortgage. Two categories of reference rates have been used in ARMs: (1) market determined rates and (2) calculated cost of funds for thrifts. The most common market determined rates used are the 1-year, 3-year or 5-year CMT and 3-month or 6-month London interbank offered rate (LIBOR). The most popular cost of funds for thrift index used is the Eleventh Fed- eral Home Loan Bank Board District Cost of Funds Index (COFI).     MORTGAGE PASSTHROUGH SECURITIES