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Basic Question 6 of 9
Holding other factors constant, the embedded option cost of mortgage pass-through securities is higher if ______
II. the mortgage pool is older.
III. the prevailing mortgage rate is higher.
I. the average contract rate is higher.
II. the mortgage pool is older.
III. the prevailing mortgage rate is higher.
User Contributed Comments 5
| User | Comment |
|---|---|
| americade | the higher the contract rate the greater the long put value just like if the stock index or security is at its highest, a long put is at its highest level. |
| danlan2 | If II and III would stimulate prepayments and increase the option cost, then II and III are right? |
| Lavay | It is the opposite of ii and iii that will stipulate prepayments |
| rhardin | I think II is correct. While older loans will mean less people refinancing, you are more likely to prepay (which is what the question is asking about.) In fact, the PSA benchmark reflects this by ramping up the prepayment over 30 months to show that a 20 month old mortgage has a greater prepayment rate than a 5 month old mortgage. |
| quanttrader | option is more in the money -- likelier to be exercised- ie option to prepay/refinance if the average rate of the contract is higher than current prevailing rates. |
I used your notes and passed ... highly recommended!
Lauren
Learning Outcome Statements
describe types and characteristics of residential mortgage-backed securities, including mortgage pass-through securities and collateralized mortgage obligations, and explain the cash flows and risks for each type
CFA® 2024 Level I Curriculum, Volume 4, Module 19.