Q&A: As the interest rates drop...

...will you expect the yields of GNMA to pick up or drop?

As interest rates drop, the prepayments start to increase and the value of a GNMA tends to approach its par amount. For a noncallable Treasury, as the interest rates drop the market value increases. Thus, the Treasuries will tend to outperform the GNMAs under those conditions. Of course, refinancing rates do not necessarily move parallel with the Treasury yields.

Premium GNMAs will have the greatest prepayment risk, although the premium burnout effect should be kept in mind. The discount and par mortgage-backed securities will also show greater prepayments.

Category: C++ Quant > Debt

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