Corrier, however, is more concerned about prepayment risk across the portfolio if economic weakness causes interest rates to decline. She reminds the investment policy committee, “Our auto loan-backed securities face the same prepayment risk that our collateralized mortgage obligations (CMOs) do.” Bakerslee points out that the firm’s investments in credit card receivable backed securities will still be in the lockout period for another two years, “so we don’t have to worry about prepayment of principal on those right now.” Regarding the statements made by Bakerslee and Corrier about prepayment risk: A) Bakerslee’s statement is correct; Corrier’s statement is incorrect. B) Bakerslee’s statement is incorrect; Corrier’s statement is incorrect. C) Bakerslee’s statement is incorrect; Corrier’s statement is correct. Your answer: B was incorrect. The correct answer was A) Bakerslee’s statement is correct; Corrier’s statement is incorrect. No principal is paid to the ABS holders during the lockout period, so there can be no prepayment risk at that time. Bakerslee’s statement is correct. The prepayments from a pool of auto loans are much more predictable and much less dependent on interest rate changes than prepayments on mortgage loans. Corrier’s statement is incorrect. (Study Session 15, LOS 46.b)
I thought if credit card backed ABS don’t perform well, the investors can call back the investment as a result this would be a prepayment risk. Am I over thinking?