Question
(a) ( 2 marks) In your own words, explain what is meant by prepayment risk. (b) Answer true or false to the following statements: (i)
(a) (2 marks) In your own words, explain what is meant by prepayment risk.
(b) Answer true or false to the following statements:
(i) (1 mark) A collateralized mortgage obligation (CMO) provides protection against credit risk.
(ii) (1 mark) Consider an Interest-Only (IO) security. If interest rates go down, the discount rate for valuing the cashflows to the IO security-holders goes down and the price of the IO security will go up.
(iii) (1 mark) Consider a Principal-Only (PO) security. If interest rates go down, the discount rate for valuing the cashflows to the PO security-holders goes down and the price of the PO security will go up.
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