At market rates substantially below the mortgage coupon rate of an interest-only (IO) mortgage-backed strip, the prepayment effect will dominate the discount effect resulting in a decrease in the price of the IO strip.

Question

Quizplus · Accepted Answer

At lower market rates, borrowers are incentivized to refinance their loans, resulting in prepayments. This prepayment effect is stronger than the discount effect (lower coupon rate), resulting in a decrease in the price of the IO strip.

At Market Rates Substantially Below the Mortgage Coupon Rate of an Interest-Only