MBS holders vs. increased interest rate volatility

not processing this answer from schweser test:

answer says: MBS include call options which increase in value with increased interest rate volatility. If rates do not fall far enough to trigger refinancings, combined with increased interest rate volatility, than this will provide a positive outcome for MBS holders.

My questions: if you are holding MBS you are effectively short a call option. the guy who took out the mortgage can call his mortgage any time, so he benefits from increased interest rate volatility, not the MBS holder. am I wrong?

I think if refinancings aren’t triggered that means interest rates don’t fall below mortgage rates then you’re in positive convexity territory, in which case the rate decline is positive for MBS. Agree with you on the volatility point though. Once again Schweser is confusing.

interest volatility is just one factor that determines the homeowner’s decision to exercise the embedded call. if interest rates are high and interest volatility is high, why would a homeowner ex the option and refinance at a higher rate,paying higher mortgage payments? In the positive convexity region, a rate decline is associated with increasing duration, so aslong as we remain in this region, rate declines are of positive value to the MBS holder.(positive convexity region)

intuitively, the option owner will only exericise if the rates are low enough and volatility high enough to make refinancing cheap.(negative convexity region)

It doesn’t make sense to me the way it’s written. Value of MBS to the holder = price of normal noncallable - price of call option The value of the call increases as interest rate volatility increases. But I guess the interoperation would be different if we think of interest rate volatility to be directional. As in the interest rates are volatile on the upside (positive convexity region) and exhibit limited volatility on the downside (negative convexity region), so that the refinancing isn’t likely. Then the MBS Holders would be safe and based on the volatility range, the value of the option is low. OMG, I don’t know what I’ve written. Never mind.

my best guess:

if refini not triggered still in positive convex territory which means MBS will outperform b/c of higher coupon payments than regular non-callable bonds

I think it simply says that the MBS price(even combined with increased interest rate volatility) still increases if the rate does not falls far enough.

Does anyone have the original question? Not sure if it’s allowed to be posted but maybe having the actual question and any necessary supporting info can clarify what’s going on here.

Q# or P# will be good enough.

Q17.5 - afternoon exam #1, volume #1.

Answer is B. it’s totally retarded, IMO. schweser is just wrong.