Again, never reflected in a spread. A maturity premium is, but not yield curve risk.
I quote from the CFAI text For a mortgage security, the spread is the sum of the option cost (i.e., the expected cost of bearing prepayment risk) and the option-adjusted spread (i.e., the risk premium for bearing the remaining risks). There are 5 principal risks in MBS: spread, interest rate, prepayment, volatility, and model risk. For a MBS, yield curve risk is considerably greater than for a Treasury security. Anyway, good luck to your exam. Answer whatever you believe and I hope that it is correct.
I don’t dispute any of the above, and I am not being difficult for the sake of being difficult, I am genuinely just saying this as noone has, in my eyes, conclusively proved that the cfa say IN THE SPREAD RISK component that there is ZERO credit risk. A Spanish cedula (covered bond) prices at 200bps over mid swaps - for a good credit. A uk one 50bps over - same maturity, in real life…and is reflected in the OAS. I am open to be persuaded otherwise with one, conclusive statement, but I am yet to see it.
I am not sure what else you need. Let me lay it out in as clear text as I can: - For a mortgage security, the spread is the sum of the option cost (i.e., the expected cost of bearing prepayment risk) and the option-adjusted spread (i.e., the risk premium for bearing the remaining risks). - What are the remaining risks? spread, interest rate, volatility, and model risk. For a MBS, there are many components of the interest rate risk: + interest rate risk as measured by level change comparable to T bonds with similar duration --> this risk is reflected in risk free rate. + interest rate risk component having to do with yield curve risk (non parallel shift). This risk is considerably greater than for a Treasury security. Some of the OAS premium is due to this sensitivity (to compensate for the bearer of the bond for this risk/uncertainty). This risk is not part of the option price. Let me quote from the bible of fixed income Handbook of fixed income from Fabozzi who writes most of CFAI fixed income materials. “Generally, the length of the investment horizon and the outlook on interest rates influence the extent to which investors may be concerned about the magnitude of the convexity effect. If the investment horizon is short and if interest rates are viewed as being stable over that time period, an investor may not be very concerned about the convexity effect. On the other hand, if the horizon spans a longer period of time, long-term price performance and convexity become larger issues. In this latter case, investors may need to be compensated for the greater exposure to negative convexity through a higher OAS, even though the two securities being compared currently may have similar effective durations.” Anyway, this is my understanding. Take it for whatever it is worth. For me, it cannot be clearer than what the CFAI has stated.