Course · Act II: Hedge the Book · Chapter 9
Callable bonds and mortgage-backed securities
Callable bonds and yield to worst, how mortgage-backed securities work, and why prepayments give them negative convexity and extension risk when rates rise.
Key terms
- Callable bond
- A bond the issuer may repay early at a set call price. It gets called when rates fall.
- Yield to worst
- The lower of yield to maturity and yield to call: the yield if the issuer acts against you.
- Mortgage-backed securities (MBS)
- Bonds that pass homeowners’ mortgage payments to investors. Agency MBS are guaranteed against default, not prepayment.
- Negative convexity
- Price gains less than duration says when rates fall and loses more when they rise. The lengthening is extension risk.
“Mortgages Pay Early” is part of the full course: 7 puzzles on callable bonds and mortgage-backed securities. Gullwing and Osprey are fictional banks; the Treasury yields and Fed rates are real. Try this act’s free chapter, “Who Sets the Short End”, first.
“Mortgages Pay Early” is in Act II: Hedge the Book. 7 puzzles, unlimited retries.
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