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Answer: Principal-only securities (POs)
## Explanation **B is correct** because Principal-only securities (POs) are most negatively affected by decreased mortgage prepayments: - **POs (Principal-only securities)**: When prepayments decrease, the principal payments get extended over a longer period. This means investors receive their principal back more slowly, reducing the present value of the cash flows since money received later is worth less than money received earlier. - **IOs (Interest-only securities)**: These would actually benefit from decreased prepayments because fewer mortgages are being paid off early, resulting in more interest payments over the security's life. - **Pass-through MBS**: The impact is more moderate and harder to predict, falling somewhere between IOs and POs. - **US Treasury bills**: These are not affected by mortgage prepayment changes at all since they are not mortgage-backed securities. **Key Concept**: POs have positive duration and benefit from faster prepayments, while IOs have negative duration and benefit from slower prepayments. When prepayments decrease, POs lose value while IOs gain value.
Author: LeetQuiz .
A risk manager at a US-based fixed-income fund expects a significant decrease in mortgage prepayments. The manager evaluates the impact of this forecast on different types of government and agency securities held in the portfolio and recommends selling the asset type with the greatest downside risk. Assuming all other factors are held constant, and the level of market interest rates is unchanged, which of the following positions should the manager recommend liquidating?
A
Interest-only securities (IOs)
B
Principal-only securities (POs)
C
Pass-through MBS
D
US Treasury bills
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