From Schweser: I don’t get the answer. Can anybody enlighten me? To focus on capturing profits from changes in the spread, a manager of mortgage security investments should hedge which of the following? A. The option-adjusted spread B. The entire spread (OAS + credit spread) C. Interest rate risk
I think the answer would be A. If you hedge out the effects of the options, you will get a more pure impact from changes in the security spreads. I think OAS either partially offsets or adds the credit spread. For example, if you buy a mortgage backed security and a put on the security, then the credit spread increases, the value of the put would increase, offsetting the drop in value in the MBS. So you’re getting returns on your options that interfere with returns on changes in the spreads. I eliminated C because the interest rate risk would affect the spread, so you would still want to keep interest rate risk in the equation (not hedge it). Am I anywhere in the ballpark?
I’m an idiot. OAS is of course the spread minus the effects of the options. I am changing my answer to C. The other two choices are spreads that you would want to profit from when you take out the effects of interest rate risk.
A. I don’t have the book with me but somehow I vaguely remember that when dealing with MBS, mgrs shld focus on OAS.
C…you want exposure to changes in spread so why would you hedge the spread? If you want to focus on profits from changing spread, you don’t want exposure to changes in the yield curve, so you hedge interest rate risk. Dwight, I think when they refer to interest rate risk they’re talking just about changes in the yield curve as a separate effect from a changing spread.
I would go with C too. Some of these questions…when i read them, I feel like deer in headlights…i read them, but nothing strikes me. I guess it shows the breath of the syllabus, the twists in the questions and my under preparedness.
I say C. You remove the IR Risk, you’re left with the spread which is what you’re trying to profit from. At least that’s what I think…
jbaldyga Wrote: ------------------------------------------------------- > Dwight, I think when they refer to interest rate > risk they’re talking just about changes in the > yield curve as a separate effect from a changing > spread. Thanks, this seems like Level 2 stuff and I never got my head 100% around this topic.
jbaldyga Wrote: ------------------------------------------------------- > C…you want exposure to changes in spread so > why would you hedge the spread? If you want to > focus on profits from changing spread, you don’t > want exposure to changes in the yield curve, so > you hedge interest rate risk. > > Dwight, I think when they refer to interest rate > risk they’re talking just about changes in the > yield curve as a separate effect from a changing > spread. Spot on. That is exactly the concept I didn’t get. I also went for A when the right answer should have been C. Thanks!
Must be C…manager capture the gain when change in spread happens, if spread risk is hedged, where is the gain coming from?
Easy question 