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Answer: Negative convexity
The embedded prepayment option makes the mortgage pass-through’s price-yield relationship **negatively convex**. As yields fall, borrowers are more likely to refinance, which limits price appreciation; as yields rise, prepayment slows, which extends duration. However, the instrument still has **positive duration**, not negative duration. So the correct effect is **negative convexity**.
Author: Manit Arora
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Question 49.2 The prepayment option creates which of the following for the price-yield curve in the cast of a mortgage pass-through?
A
Negative duration
B
Negative convexity
C
Both negative duration and negative convexity
D
Neither negative duration nor negative convexity
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