“HEDGING MORTGAGE SECURITIES TO CAPTURE RELATIVE VALUE” THE CANDID...

30. “Hedging Mortgage Securities to Capture Relative Value” The candidate should be able to: a) demonstrate how a mortgage security’s negative convexity will affect the performance of a hedge; b) explain the risks associated with investing in mortgage securities and discuss whether these risks can be effectively hedged; d) compare and contrast duration-based approaches versus interest rate sensitivity approaches to hedging mortgage securities; 2008 Level III Guideline Answers Morning Session – Page 18 of 40 Question: 5 Topic: Portfolio Management – Fixed Income Investments Minutes: 13 Guideline Answer: PART A Template for Question 5-A Note: Ignore transaction costs. Determine the expected effect on the portfolio’s value over the next two weeks Justify each expectation with one Trade for each potential reason. trade, given the strategist’s market expectations. (circle one) Lower quality corporate bond spreads Positive widen more than higher quality bond