Mortgage securities spread risk

CFA Level III
#1

In the schweser book, they first define spread risk as the risk of of mortage security’s yield over the T-bond widening.

Then when discussing the actions a manager should do when he doesn;t hedge the spread risk they said if there is an increase in the spread , the manager should increase the exposure to mortgage securities?

Don’t these two statements contradict each other?

I thought increase in spread, means decrease in the price of the security and therefore the manager should try to underweight the security.

I would appreciate if anyone can clarify this please!

#2

MBS will outperform other non-callable bonds in a bear bond market due to their call premium

so if you must buy bonds, you want to buy MBS in a bear bond market (when spreads are increasing)

#3

One phrase sums this up:

Buy low, sell high

I don’t think they specifically mention it in the books, but that the basic principle behind this.

#4

Agreed. Constant Mix, which is a contrarian strategy, is the implied strategy in all study sessions. It based on the assumption of mean reversion…IMHO, this may also be the root cause of Subprime crisis. All are seeking the same risk - spread risk.

#5

this was a question on the schweser #1 afternoon exam, it was about hedging MBS with 2 and 10 year bonds but leaving the spread unhedged because the OAS was very high and should revert to the mean thus increasing price

#6

Thanks guys! It’s clear now!