Can someone please explain the logic behind this answer. As I thought MBS gives right of prepayment hence it behaves more like a puttable bond and therefore with an increase in volatility, value of MBS portfolio will increase and therefore option A cannot be an answer.
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Why would the pre-payment feature of an MBS be even remotely akin to a Puttable Bond? It’s clearly akin to a callable bond.
Think about what happens when interest rate falls :
Hence, an MBS is similar to a Callable and not Puttable bond. Hence, an increase in benchmark YC volatility would increase the value of the Call Option and thereby, decrease the MBS value.
Hope it’s clear now.