26-48 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

When market rates are lower than the coupon rate of an IO mortgage-backed strip, borrowers are likely to prepay their mortgages, which results in a decrease in the price of the IO strip. This is known as the prepayment effect, and it dominates over the discount effect when market rates are substantially below the coupon rate. Therefore, the statement is true.

26-48 at Market Rates Substantially Below the Mortgage Coupon Rate