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KIC000084 - nuts Risk from Investing in Mortgages I...

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Unformatted text preview: nuts} Risk from Investing in Mortgages I Interest rate risk uMort age prices decline in response to an -— in interest rates uMortgages are commonly financed by financial institutions with short-ten‘n deposits [Mortgages can generate high returns when interest rates fall, but gains are limited because borrowers tend to refinance l i .1 I,” Manage - interest rate risk I Interest rate risk (cont‘d) El Limiting exposure to interest rate risk - Financial instimtlons can: u ‘49— shortly alter originating them a Maintain residential mortgages in Invest in fixed-rate mortgages with a short time remaimng tn nietuity .._-;.-i- . ‘M Prepayment risk EiPrepayment risk is the risk that a borrower rn repay the mortgage in response to afi— in interest rates nThe investor receives payment and has to reinvest at the lower interest rate DLimiting exposure to prepayment risk - F inancial institutions can sell loans shortly after originating them or invest in adjustable-rate mortgages ...
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