do values of IO mortgage strips go up as interest rates go up and down as interest rates go down? since cash flow increase will more than offset the higher discount rate… however, i think i read it somewhere that when rates go up, IO mortgage strip value is unclear due to higher rate… hummm, so, which one is true? Thanks much =)
yes, interest rate go up, there would be extension risk, people don’t want to prepay that fast, therefore IO increases value
yes, as interest rates go up, IO strips go up in value, because prepayments are less.
this was on the mock exam, screwed me up
according to answer in the mock up, when interest rate goes above contract rate, IO value MIGHT NOT go up…the net effect may either be a rise or fall in IO value… seems different from what people say in here?
It depends on whether the change in rates is greater than the change in your cash flow yield. It is unclear whether or not they will go up or down.
It goes up… but you discount it @ a higher rate… so the net effect depends on the level of interest rates…
yeah, smaller rate increase - IO does increase in value, however, if its a big rate increase, the future cash flows will be discounted at a higher rate, and thus the value will go DOWN. Tricky - hope that if CFAI asks this, they make it very very clear.