Advanced Portfolio Management Flashcards

A portfolio manager notices that a pool of fixed-rate mortgages extends in average life when rates rise. What is this risk called?

Answer: Extension risk

Extension risk occurs when rising rates slow prepayments and lengthen the expected life of mortgage assets.

Why do mortgage-backed securities typically exhibit negative convexity?

Answer: Borrowers' prepayment option shortens duration as rates fall

The embedded prepayment option caps price appreciation when rates fall, producing negative convexity.

A 100% PSA prepayment assumption implies what annualized CPR once the pool reaches month 30?

Answer: 6%

The PSA benchmark ramps 0.2% CPR per month to a constant 6% CPR at month 30 and thereafter.

Which metric best captures the price sensitivity of a mortgage asset after accounting for changing cash flows from prepayments?

Answer: Effective duration

Effective duration uses option-adjusted pricing under rate shocks, capturing prepayment-driven cash-flow changes.

A lender holds a large concentration of loans in a single metropolitan area. Which risk is most directly elevated?

Answer: Geographic concentration credit risk

Concentration in one market exposes the portfolio to correlated defaults from a local economic or price shock.

What does the option-adjusted spread (OAS) on a mortgage asset represent?

Answer: Spread over the benchmark curve after removing the cost of the embedded prepayment option

OAS strips out the value of the borrower's option, leaving compensation for credit, liquidity, and model risk.

Under CECL, how must a lender estimate credit losses on held-for-investment mortgage loans?

Answer: Expected losses over the contractual life adjusted for prepayments

CECL requires lifetime expected credit loss estimates using reasonable and supportable forecasts.