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Answer: When interest rates fall, its price increase would lag that of a comparable duration U.S. Treasury bond.
Low premium mortgage pass-through securities exhibit negative convexity due to prepayment risk. When interest rates fall, homeowners are more likely to refinance their mortgages, leading to accelerated prepayments. This prepayment risk means that: - The security's price appreciation is limited because investors receive their principal back sooner than expected - The security has a shorter effective duration than originally anticipated - The price increase lags behind comparable duration Treasury bonds, which don't have prepayment risk This phenomenon is known as 'price compression' or 'negative convexity' - the security's price doesn't rise as much as a non-callable bond when rates decline.
Author: LeetQuiz Editorial Team
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How would you describe the typical price behavior of a low premium mortgage pass-through security?
A
It is similar to a U.S. Treasury bond.
B
It is similar to a plain-vanilla corporate bond.
C
When interest rates fall, its price increase would exceed that of a comparable duration U.S. Treasury bond.
D
When interest rates fall, its price increase would lag that of a comparable duration U.S. Treasury bond.
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