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LOS b: Explain the risks associated with investing in mortgage securities and discuss whether these risks can be effectively hedged. ffice ffice" />
Q1. The effects of recent technological and institutional innovations on the market for mortgage-backed securities has increased:
A) volatility risk.
B) model risk.
C) spread risk.
Correct answer is B)
The innovations have had a direct effect on the ability of models to predict prepayment rates.
Q2. All of the following are risks associated with mortgage securities EXCEPT:
A) volatility risk.
B) model risk.
C) beta risk.
Correct answer is C)
Beta is not generally a concept directly associated with mortgage securities. Model risk is important because the current value depends upon patterns of interest rates and prepayment rates. The changing spread can influence the asset’s value. Because of the embedded option, volatility risk is important too.
Q3. If a manager of mortgage backed securities is not hedging spread risk, the most likely reason is because hedging spread risk:
A) is impossible.
B) increases volatility risk.
C) reduces profitable opportunities.
Correct answer is C)
A manager can earn profits by buying mortgage backed securities when the spread widens and selling when the spread narrows.
Q4. Negative convexity is more likely to become more severe if:
A) volatility decreases.
B) the spread increases.
C) volatility increases.
Correct answer is C)
Negative convexity can be interpreted as the negative effect on price caused by an increase in the value of the embedded, short call option in the mortgage security. An increase in volatility will increase the value of that option and increase the severity of the negative convexity. An increase in the spread and/or Treasury rate will likely increase the yield of the mortgage security, and this will tend to make the security’s convexity more positive.
Q5. An increase in the credit spread of a mortgage backed security:
A) decreases the security’s value relative to Treasuries.
B) increases the security’s value relative to Treasuries.
C) does not change the security’s value relative to Treasuries.
Correct answer is A)
An increase in the spread means the yield of the mortgage backed security has increased relative to Treasuries so the security’s value has decreased relative to Treasuries. This would be an opportunity to buy mortgage backed securities.
Q6. In analyzing the risk of mortgage backed securities, we say that:
A) interest rate risk is a component of spread risk.
B) interest rate risk and spread risk are distinct measures.
C) spread risk is a component of interest rate risk.
Correct answer is B)
Interest rate risk is associated with the risk from movements in Treasury securities. Spread risk is a separate component associated with the credit properties of the security as well as macroeconomic factors.
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发表于 2009-3-6 11:04
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