1.Richard Myers, CFA, diversifies his client’s fixed income portfolio into different types of mortgage-backed securities. He is now building a portfolio and has forecasted a scenario of rising interest rates over the planning horizon. His assistant has prepared a graph depicting the relationship between mortgage interest rates (low at the origin, higher going out to the right) and prices for three different types of mortgage-backed securities labeled as A, B, and C.
 此主题相关图片如下：2.gif
 Letter A represents which type of mortgage backed security?
A) Interest-only strip.
A) Interest-only strip. B) Principal-only strip. C) Passthrough. D) Paythrough. The correct answer was C) Letter A is a passthrough security. The passthrough security is an amortizing security that contains prepayment risk to the investor. The negative convexity is evident in the low interest rate environment (when prepayments are high), and the value of the passthrough falls as mortgage rates rise (when prepayments fall), typical of any option-free fixed income security. 2.Letter B represents which type of mortgage backed security? A) Interest-only strip. B) Passthrough. C) Principal-only strip. D) Paythrough. The correct answer was A) Letter B is an interest-only strip. The interest-only strip behaves in a way that’s unique to fixed income securities—its value is directly related to movement in interest rates. When interest rates are low, prepayments are high and the expected level of coupon interest fails to materialize. When interest rates are high, prepayments are low and the expected cash flows improve. 3.Letter C represents which type of mortgage backed security? A) Passthrough. B) Paythrough. C) Interest-only strip. D) Principal-only strip. The correct answer was D) Letter C is a principal-only strip. The principal-only strip has cash flows that are similar to a zero coupon bond. Higher prepayment rates result in faster than expected return of principal and, thus, a higher yield. However, higher interest rates results in a heavier price of discounting and, thus, a lower yield. 4.Myers is also considering collateralized mortgage obligation (CMO) tranches for his client. His assistant has developed the following graph depicting the relationship between types of CMO tranches and risk. Tranche | Risk Type #1 | Risk Type #2 | A (sequential pay) | HIGHEST | LOWEST | B (sequential pay) | HIGH | LOW | C (sequential pay) | MEDIUM | MEDIUM | D (sequential pay) | LOW | HIGH | Z (accrual) | LOWEST | HIGHEST |
Which of the following describes the risks associated with
Risk Type #1 and Risk Type #2? A) Risk Type #1, contraction risk; Risk Type #2, extension risk. B) Risk Type #1, extension risk; Risk Type #2, contraction risk. C) Risk Type #1, prepayment risk; Risk Type #2, extension risk. D) Risk Type #1, contraction risk; Risk Type #2, default risk. The correct answer was A) Risk Type #1 = contraction risk; Risk Type #2 = extension risk Contraction risk refers to the shortening of the expected life of the mortgage pool due to falling interest rates and higher prepayment rates. There are two undesirable consequences for passthrough investors when interest rates decline. First, the security exhibits negative convexity, meaning that the opportunity for gains when rates fall is taken away. Second the security receives heavier than expected cash flows at the wrong time because low interest rates increase the reinvestment risk of the investment. Extension risk refers to the lengthening of the life of the security as interest rates rise. With passthrough securities, the decrease in prepayments compounds the price decline because the lower than expected cash flows occur at the wrong time because investors would rather recapture their principal as soon as possible when rates are high. For sequential pay CMO tranches, each class of bond gets retired sequentially, meaning that tranche A gets retired first, then tranche B, and so on. The Z tranche is the last tranche to be repaid and does not receive current interest until the other tranches have been paid off. Thus, the early payment tranches, beginning with tranche A, have the highest amount of prepayment risk and get retired first. Here the contraction is great, and the probability of extension is small. However, the late tranches, especially the Z tranche, receives little if any prepayments and suffers low to no contraction risk but high risk of extending the life of the security. 5.How is the price of an interest-only mortgage strip affected by declining mortgage rates in the market below the contract rate? The price of the interest-only strip: A) increases. B) decreases. C) is unaffected. D) may increase or decrease. The correct answer was B) When mortgage rates decline, prepayments are expected to increase. This results in a deterioration of the expected cash flows from an interest-only strip.
[此贴子已经被作者于2008-5-14 17:22:41编辑过] | 
发表于 2008-5-14 17:18
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