Answer: c) At high yields, as rates increase, the price of IO increases dramatically due to higher coupons

An **IO strip** receives only the interest portion of mortgage payments. When rates are high, prepayments tend to be slower, so the IO can behave more like a security with more predictable cash flows. When rates fall, prepayments speed up and the IO loses valuable future interest payments, so its price can fall sharply. IOs often have **negative duration** because they tend to lose value when rates fall and gain value when rates rise. The false statement is that at high yields, the IO price increases dramatically **due to higher coupons**; the IO does not benefit from higher coupons in that way, since its value is driven mainly by the expected life of the interest stream, not by a growing coupon rate.

Author: Manit Arora