iteracom

Agree that negative convexity exists in callable bonds?

A calable bond does not get the full gain from a drop in interest rates because if rates drop enough its price would rise and it would be called

MBS exibit a similar issue, if rates drop, you would think its a good thing, waw everyone wants to buy my 10% MBS now from me, since the market is paying 8% on new MBS

well the problem is soon a lot of people are going to prepay, and whoever owns that 10% MBS is screwed by having to reinvest at 8%, and that works like the call option capping the price



Edited 2 time(s). Last edit at Thursday, May 19, 2011 at 06:44PM by gulfcfa.