1. a) Why does mortgage prepayment risk create the need for banks to hedge their mortgage holdings when interest rates are falling? How are the banks NIM and duration gap impacted by prepayments?

b) How could they hedge prepayment risk with i) swaps, ii) futures and iii) spot long term Treasuries? Explain and be specific. i) Swaps: They could hedge prepayment risk with swaps when the ii) Futures: iii) spot long term Treasuries: