Which of the following statements about mortgage-backed security strips is true?
A)both interest-only and principal-only strips are subject to pre-payment risk
B)only principal-only strips are subject to prepayment risk
C)only interest-only strips are subject to prepayment risk
D)the prepayment risk of interest-only and principal-only strips is precisely offsetting
E)none of the above

Question

Quizplus · Accepted Answer

Both interest-only and principal-only strips are subject to pre-payment risk. This is because pre-payment risk affects the underlying mortgages that make up the MBS, and both strips are derived from those mortgages. Interest-only strips receive only the interest payments from the underlying mortgages, while principal-only strips receive only the principal payments. If the mortgages are paid off early, either strip can be affected.

Which of the Following Statements About Mortgage-Backed Security Strips Is