Prepayment risk is the cause of the negative convexity, which means the mortgage security loses more from a given increase in yield than it gains from a corresponding decrease in yield. This is why an unhedged mortgage security is called a market directional investment. ============================================================== In the above contents in Schweser explaning fixed income, I would like to know what the market directional means. As read the forum I saw the word and I realized I don’t know the meaning. when R increases : large loss in value when R decreases : small gain in value (in negative convexity) I could understand the concept but how this is related with the word market directional?
Market directional means that an investment is attractive only when it moves in a certain direction. From your example, it means when R decreases.
Just to clarify, MBS should be considered in a rising rate environment since duration tends to increase because of lower prepayments.