Reading 32: Hedging Mortgage Securities to Capture Relati

par, positive, infinite, mortgage, increase

LOS a: Demonstrate how a mortgage security's negative convexity will affect the performance of a hedge.

Q1. For a mortgage backed security trading at par, a large increase in market rates is most likely to make the security’s convexity:

A) become infinite.

B) go from negative to positive.

C) go from positive to negative.

Q2. For a mortgage security trading at par and a hedge formed with a short position in a Treasury futures position that is designed to maintain a stable value, the hedge would still be effective if:

A) there is a 100 basis point decrease in yield.

B) there is a 75 basis point decrease in yield.

C) there is a 100 basis point increase in yield.

Q3. A portfolio manager has used a Treasury bond futures contract to hedge a mortgage security, which is trading at par, against a decrease in value from a 50 basis point increase in yield. If the yield were to decrease 50 basis points, the most likely result is:

A) the net value of the position with the hedge will increase.

B) the net value of the position with the hedge will decline.

C) the net value of the position with the hedge will not change.

Q4. A mortgage security is most likely to exhibit positive convexity if:

A) the yield curve has a parallel downward shift.

B) the price is below par.

C) the price is above par.

Q5. A mortgage security with a face value had a price of 99 at the opening of the trading day. During the day, the yield declined by 80 basis points below its opening yield and then increased 80 basis points above its opening yield. The corresponding prices of the instrument were 99.5 and 98 respectively. From this we can say the security:

A) exhibited negative convexity.

B) exhibited excess volatility.

C) exhibited positive convexity.

Q6. Hedging a mortgage security with a short Treasury futures contract is most effective if:

A) it is trading above par.

B) it is trading at par.

C) it is trading below par.

Q7. A mortgage security’s convexity is most likely to become negative if the market yield is:

A) increasing and the price moves below par.

B) declining and the price moves below par.

C) declining and the price moves above par.