I/O strip value goes up and goes down

CFA Level II
#1

Is the consensus on the I/O strip value when Interest Rate goes up… I/O strip value goes up and goes down ? I got this wrong…looks like… I picked …The Value goes up and stays up…

#2

the I/O value goes up as interest rate goes up…negative duration. pretty sure on this one.

#3

WYM Wrote: ------------------------------------------------------- > the I/O value goes up as interest rate goes > up…negative duration. pretty sure on this one. Not quite. The correct answer was the value of an IO goes up to a point, and then starts to decrease.

#4

why decrease? the I/O value goes up as interest rate goes up due to the slower the prepayment speed. I can see that if the interest rate is high enough that its impact on prepayment rate start to deminish, the I/O value stabilizes. But don’t see why it starts to decrease.

#5

It starts to decrease because rates are higher. A regular bond’s value falls when rates go up. So it starts to go up and then as rates increase further it starts to fall.

#6

there is a picture in CFAI materials. IO values goes up and then goes down. Here is why it goes down: you get paid same coupons that are relatively small vs actual rates (when rates go up a lot)

#7

As rate goes up, price of IO goes up. When the rate increased to a certain level, the price start to decline. CFAI - Volume 5 p.203

#8

still no convinced, folks… if ytm of an I/O is 5% and the prevailing market rate is also 5% and start to go up, is the value of the I/O start to go up or down?

#9

Dude, it was right out of one of the practice exams…Schweser maybe. It’s a direct relationship to a point (goes up), but then declines, for the reasons that buddy stated above. This ONE question I can say with confidence I got right!

#10

WYM Wrote: ------------------------------------------------------- > still no convinced, folks… > > if ytm of an I/O is 5% and the prevailing market > rate is also 5% and start to go up, is the value > of the I/O start to go up or down? Here’s the deal: It initially goes up as rates rise, because the risk of prepayment goes down. Therefore, it has more value. But, once rates get so high (let’s say, 12%), the risk of prepayment is virtually nil, because people aren’t going to be refinancing when rates are so high. So, now the bond will act like a normal bond and the value will decrease as rates rise. So, as the correct answer stated, the bond value will go up as rates rise to a point, and then as rates rise further the bond value will decrease.

#11

I start to see the point…lost another one. I think I should prepare for rewriting the exam next year. Good luck for the rest of you!

#12

I don’t even remember that being an answer… damn. I just picked goes up and moved to the next question.

#13

maratikus Wrote: ------------------------------------------------------- > there is a picture in CFAI materials. IO values > goes up and then goes down. Here is why it goes > down: you get paid same coupons that are > relatively small vs actual rates (when rates go up > a lot) —also cos you’re discounting at increasingly higher rates when rate goes up

#14

I picked A), can anyone confirm…?

#15

preetchawla Wrote: ------------------------------------------------------- > I picked A), can anyone confirm…? It wasn’t A. Don’t remember what letter it was, but I’m pretty sure it was B or C.

#16

Does anyone remember what were the other options for this question? Now I am confused.

#17

FlyingCFA Wrote: ------------------------------------------------------- > Does anyone remember what were the other options > for this question? Now I am confused. i thought the question was what happens if rates rise only possible correct options were 1 - goes up 2 - goes up and then is steady