medium · Asset-Backed Securities collateral
Why does an Interest-Only (IO) strip have 'negative duration' in many interest rate scenarios?
- Because most IO strips are typically structured as floating-rate notes subject to periodic LIBOR interest rate caps
- It primarily reflects the well-documented 'burnout' effect observed within the underlying mortgage loan collateral pool
- When interest rates fall, prepayments accelerate, reducing the total interest cash flows and causing the bond price to drop
- When interest rates rise, the applicable discount factor increases at a faster pace than the projected coupon income stream received
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