SIE Exam Question 400: Answer and Explanation

Question: 400

One of the primary risks associated with mortgage backed securities is prepayment risk. This tends to present itself when

• A. inflation is increasing
• B. the Fed reduces interest rates
• C. the dollar is strong
• D. none of the above

Correct Answer: B

Explanation:

B: What do many homeowners do when interest rates decline? They refinance their mortgage at the lower interest rate. This means the high-interest mortgages in the portfolio of the mortgage-backed product will vanish. One term used to describe the risk of this occurring is prepayment risk.