Hedging spread risk of MBS

sample exam 2. Why should we NOT hedge spread risk if spreads are expected to widen? - sticky

because you can make money on mortgages.

B/c the reason you hold MBS’s is for their Spread. YOU NEVER HEDGE MBS SPREAD, remember that for the test :slight_smile:

Yeah, I am not sure I agree with their explanation. “Instead Fan should invest in mortgage securities when spreads are wide”. What if he already owns morgage securities and expects spreads to widen?!

tanyusha Wrote: ------------------------------------------------------- “Instead Fan should invest in mortgage securities when spreads are wide”. This statement from the solution sounds as BS as “Fan should invest in a bond right before it drops yield.”

He should double down ;0

100% NO hedging of spread risk for MBS because that is a source of your return. hedge everything else!

bigwilly Wrote: ------------------------------------------------------- > He should double down ;0 Sigh. Spoken like a trader.

sticky Wrote: ------------------------------------------------------- > tanyusha Wrote: > -------------------------------------------------- > ----- > “Instead Fan should invest in mortgage securities > when spreads are wide”. > > This statement from the solution sounds as BS as > “Fan should invest in a bond right before it drops > yield.” If spreads are wide, that sort of implies you expect them to narrow. If you expect spreads to narrow, you want to invest in securities with spreads because their price will go up when spreads narrow. Same thing for yields. If they are high, then bond prices are low. If you expect yields to decrease, that means you expect bond prices to rise and would want to invest in them. The whole point of investing in MBS is to make money on spread movements. If you hedge spread risk of MBS, you are essentially turning them into gov’t bonds. If you are going to hedge spread risk, you might as well just buy gov’t bonds and earn the risk-free rate.

hezagenius Wrote: ------------------------------------------------------- > sticky Wrote: > -------------------------------------------------- > ----- > > tanyusha Wrote: > > > -------------------------------------------------- > > > ----- > > “Instead Fan should invest in mortgage > securities > > when spreads are wide”. > > > > This statement from the solution sounds as BS > as > > “Fan should invest in a bond right before it > drops > > yield.” > > > If spreads are wide, that sort of implies you > expect them to narrow. Tell it to LTCM. If spreads are wide, you can expect them to, uh, I dunno…

Sorry guys, still thinking of this one. I agree you are investing in an MBS for the spread. But you’re return on them is when spreads narrow. Still can’t figure out why you would hedge if the spread widen? It seems to make sense with options too?

tanyusha Wrote: ------------------------------------------------------- > Yeah, I am not sure I agree with their > explanation. “Instead Fan should invest in > mortgage securities when spreads are wide”. What > if he already owns morgage securities and expects > spreads to widen?! Agree with you 100%. Explanation is BS. The only reason this is the correct answer is because it’s what the book says in the end of chapter question.