Pick the correct statement regarding Mortgage Backed Securities: a) if the long end of the yield curve is unchanged, but the short end of the yield curve (up to year 7) decreases, the PO’s value will increase as its effective duration is positive. b) if the long end of the yield curve is unchanged, but the short end of the yield curve (up to year 7) decreases, the PO’s value will decline despite an effective duration that is positive. c) IOs have a high positive duration.
b) There is a KRD diagram in the curriculum…It’s related to the prepayment. I choose C) only based on my memeory of PO shape.
agreed - b) POs value is increased when probability of prepayment increases (receive money sooner = worth more) which is the case given a fall in the yield curve. sound right?
Just finished to study FI, so B. PO exhibits high effective duration but have low short term negative duration so if ST of YC decreases, prices will decrease.
B for the win
might sound stupid…but whats a PO…cant recalll
principal only. Generally answer will be b, but the longer real life answer is that it depends on the past yc and characteristics of the underlying pool (pp burnout)
sk22. why pick B if you think the money is worth more if you receive it sooner? you don’t want the money back now.
PO have high effective positive duration but on the short term have low negative duration. Meaning that borrowers will probably not refinance right away after taking out a 30Y mtge. Maybe after 10 years.
Just wondering why C is not correct. If int rates rise less people refinance and the longer the IO duration, so IO would increase in value. Increase in int rates --> increase in value = Positive Duration, correct? Am I wrong?
Its b) most of you got it right. The answer has to do with the shape of the duration profile for POs. POs have negatie duration in the short term and positive duration in the long term. Overall their duration is positive. POs have exposure to yield curve risk. Book 4 Page 171 IOs have high negative duration.
crap, I keep forgetting: Negative sign = positive duration. Why does Fixed Income have to be a continual battle with double negatives!
FinNinja Wrote: ------------------------------------------------------- > crap, I keep forgetting: Negative sign = positive > duration. > > Why does Fixed Income have to be a continual > battle with double negatives! Simple rule: Positive duration - value and interest rates go in opposite directions (negative correlation). Negative duration - value and interest rates go in the same direction (positive correlation).
What’s name for (foreign bond duration * country beta)?