medium · Asset-Backed Securities collateral
An investor is comparing two ABS bonds with identical 3.5-year WALs. Bond X is priced at 103.50 (Premium) and Bond Y is priced at 96.50 (Discount).
If both bonds experience a parallel slowdown in prepayments (extension risk), which bond's yield-to-maturity is more negatively impacted?
- Bond Y, because the realization of the purchase discount is deferred further into the future.
- Both bonds are impacted equally since their initial durations are identical at pricing
- Bond X, because the investor keeps earning the high coupon for a longer duration overall
- Bond X, because deferring the 3.50 point capital loss to a later date benefits the investor's return
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