medium · Debt Capital Markets pricing-yields-curve
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 rises sharply as lower rates squeeze household budgets.
- The bond's price will climb faster than a comparable on-the-run Treasury during the rate rally.
- Prepayments will accelerate, returning principal to investors just as reinvestment yields are falling.
- The duration of the bond lengthens substantially, leaving it far more sensitive to additional rate cuts.
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