Ms. Xu is the senior portfolio manager for the Solid Income Mutual Fund. Th e fund invests primarily in investment-grade credit and agency mortgage-backed securities. For each quarterly meeting of the board of directors of the mutual fund, Ms. Xu provides information on the characteristics of the portfolio and changes in the composition of the portfolio since the previous board meeting. One of the board members notices two changes in the composition of the portfolio. First, he notices that while the percentage of the portfolio invested in credit was unchanged, there was a sizeable reduction in callable credit relative to noncallable credit bonds. Second, while the portfolio had the same percentage of mortgage passthrough securities, there was a greater percentage of low-coupon securities relative to high-coupon securities.

When Ms. Xu was asked why she changed the structural characteristics of the securities in the portfolio, she responded that it was because the management team expects a significant drop in interest rates in the next quarter and the new structures would benefi t more from declining interest rates than the structures held in the previous quarter. One of the directors asked why. How should Ms. Xu respond?