| IO strips | PO strips | |
| favorable prepayments | slow | fast |
| investors' concern | contraction risk | extension risk |
| favorable market interest rate movement | up (*1) | down (*2) |
| price volatility vs. the passthroughs from which they are derived | greater (*3) | greater (*3) |
(*1) Larger than expected principal balance and thus, larger than expected interest payments.
(*2) Larger than expected prepayments, that is, early return of principal and higher return on the security.
(*3) The IO and PO returns are negatively correlated (they respond in opposite directions to changes in interest rates), but the volatility of the combined IO and PO strips equals the price volatility of the source passthrough.
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