Which of the following is a problem with computing the cash flow yield of an agency mortgage-backed security? A) There is default risk. B) The principal is variable. C) The cash flows are unknown. D) There is interest rate risk.
Meant to put C, formatting was messed up on my computer
C… cash flow timing uncertainty?
yeah, easy it’s a C.
cash flow yield = IRR (that is how i remember it) if you do not know the CF you cannot compute IRR. C
c The cash flows are unknown
Isnt there interest rate risk as well? How do you know what to use when discounting the Cash flows? PLUS the rates are what causes CF uncertainty b/c as rates decline it has a direct impact on refinancing.
Yes, but that risk is inherent in any fixed income investment. The question is asking specifically for MBS. I know what your saying AF, I think the main point CFAI is making here is that you absolutely must know that MBS have uncertain cash flows due to prepayments