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Answer: When interest rates fall, its price increase would lag that of a comparable duration U.S. Treasury bond.
## Explanation Low premium mortgage pass-through securities exhibit **negative convexity** due to prepayment risk. When interest rates fall: - **U.S. Treasury bonds** show positive convexity - their prices rise more than proportionally as rates fall - **Mortgage pass-throughs** with low premiums experience increased prepayment risk as homeowners refinance at lower rates - This prepayment risk creates **price compression** - the price increase lags behind comparable duration Treasury bonds - The security's effective duration decreases as rates fall, limiting price appreciation This behavior is characteristic of mortgage-backed securities and reflects the embedded prepayment option held by homeowners.
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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.