FRM II-MR 17

anbu.edu
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FRM II-MR 17

Postby anbu.edu » Mon Sep 08, 2014 6:39 am

Which of the following statements regarding principal-only (PO) and interest-only (IO) strips is (are) CORRECT?
I. The IO price is positively related to mortgage rates at low current rates.
II. The IO exhibits some negative convexity at low rates.
III. PO strips are sold at a moderate discount to par.
IV. PO prices increase when interest rates fall.
A) I and IV.
B) I and II.
C) II and III.
D) III and IV.
Your answer: B was incorrect. The correct answer was A) I and IV.
The PO (not IO) exhibits some negative convexity at low rates.
PO strips are sold at a considerable (not moderate) discount to par.

Can anyone explain why IO does not exhibit negative convexity

edupristine
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Joined: Wed Apr 09, 2014 6:28 am

FRM II-MR 17

Postby edupristine » Fri Sep 12, 2014 12:11 pm

IO does not exhibit negative convexity because it has positive relationship with interest rate if interest rate fall the price of IO will also fall down.


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