hard · Debt Capital Markets
Which of the following describes the impact of 'negative convexity' on a residential mortgage-backed security (RMBS) as interest rates decline?
- The credit risk of the underlying borrowers will increase due to lower rates.
- The bond's price will rise faster than a comparable Treasury bond.
- Prepayments will accelerate, returning principal to investors just as reinvestment yields are falling.
- The duration of the bond will increase, making it more sensitive to further rate cuts.
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