A PO is a "principal only" MBS and an IO is an "interest only" MBS. As prepayments increase which of the following happens.

Question

Quizplus · Accepted Answer

As prepayments increase, the principal balance of the underlying mortgage decreases faster, resulting in an earlier return of principal for the PO holder. This increase in principal payments makes the PO more valuable. However, because the IO receives less interest income from the underlying mortgage as prepayments increase, the IO becomes less valuable. Therefore, the answer is B, the PO becomes more valuable, and the IO becomes less valuable.

A PO Is a "Principal Only" MBS and an IO