What are the critical assumptions underlying the hedging of a mortgage security? CFAI R31EOC Q 7 I believe it’s about two bond hedge.

- Yield curve shifts used to construct hedge are reasonable 2) Prepayment model is good estimator of CF changes when yield curve shifts 3) Monte Carlo simulation assumptions are realized 4) Avg price change for small yield curve changes is good approximation of how MBS will move (may not apply to cuspy-coupon)

that the analyst knows algebra

Yield can move down to 0, but not negative, Prepayment speed can go down to 0, but not negative; MC simulation can be run on iPhone, but not on 12C. MC Simulation uses average price, don’t know why it’s a separate assumption.(from cfai book, i think) Suggest replacing it with skip’s algebra assumption.

Thank june2009 for the complete answer.

Doesn’t it also assume 0 credit losses? Or is that related to some other fixed income reading?

bpdulog Wrote: ------------------------------------------------------- > Doesn’t it also assume 0 credit losses? Or is that > related to some other fixed income reading? I think it would have to assume that, as the treasuries would have zero credit risk.