CPR / Extension Risk question

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plyon

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Houston has come up with four potential relationships between conditional prepayment rates (CPRs) and extension and contraction risk for a MBS. Which of the following statements is least accurate?
A) Extension risk is associated with the likelihood of actual prepayments being less than the assumed CPR.
B) Extension risk is associated with the likelihood of actual prepayments being equal to the assumed CPR.
C) Contraction risk is associated with the likelihood of actual prepayments being less than the assumed CPR.
D) Contraction risk is associated with the likelihood of actual prepayments being equal to the assumed CPR.
 
C.
When prepayments are less than assumed, the return of principle is delayed longer than expected, resulting in extension of reinvestment risk.
 
I think I remember seeing this question… I am convinced schweser is wrong in their answer. All statements seem to be incorrect except for statement A. Unless there is something I am completely missing here.
so my answer is B,C, and D
 
patkeenan Wrote:
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> I think I remember seeing this question… I am
> convinced schweser is wrong in their answer. All
> statements seem to be incorrect except for
> statement A. Unless there is something I am
> completely missing here.
>
> so my answer is B,C, and D
This is exactly what I think, too. (I didn’t want to give it away up front).
I also agree that “C” is the LEAST accurate.
Here’s Schweser’s official answer:
Your answer: C was incorrect. The correct answer was A) Extension risk is associated with the likelihood of actual prepayments being less than the assumed CPR.
When prepayments are slower than anticipated by the CPR, the MBS will take longer to pay off its principal, resulting in an extension of its maturity.
I guess I’ll have to send them an email. Anyone here disagree???
 
With mwvt in my court, I felt I could justify sending an errata report!
I’ll let you guys know what I hear back, but I agree — this one’s pretty clear.
 
plyon Wrote:
——————————————————-
> With mwvt in my court, I felt I could justify
> sending an errata report!
>
>
> I’ll let you guys know what I hear back, but I
> agree — this one’s pretty clear.
HA! Yeah let’s set them schweser boys straight.
 
B and C aren’t true, but if we had to pick the LEAST accurate we would go with C.
 
JoeyDVivre Wrote:
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> Anyway, are you doing okay plyon?
Thanks for asking… Yeah… not bad.
I’ve actually been almost too busy to think about it much (12 years with one company is along time). But I’ve got this exam to tackle / crush (and was somewhat behind as the pressure at work had been pretty intense lately).
Plus, we closed on a house near the water down here in CT the same week I got canned (had to find a new lawyer and new mortgage company with 5 days notice, too – no easy feat). I’m one town over from the River Cat. Anyway… thing needs a bunch of work – all of which we were going to do over the next 5 years or so. Now we’re basically hitting all the highlights of all these projects on some sort of super accelerated schedule in case we’ve got to flip this house later this fall or early next year when the cash runs out. We bought it privately, so we could actually turn a small profit potentially (although I’m more about stop - loss than anything else right now).
Real shame to have to move the family all around because of this but we knew what we were doing, buying a house speculatively like that (it really was more than I should have bought, but I sold my other house nearly 2 years ago and made enough to be able to risk jumping back in on the dip).
So the short answer is that I’ve not yet really started looking hard (had a couple quick phone interviews but the positions weren’t really my expertise). Not sure what I’m going to experience out there when I really hit the pavement. At the end of the day, its amazing how quickly your experience pigeon-holes you. And most money funds are being run virtually by committee now, not by overpaid PMs with a boat-load of discretionary authority (it gets less fun every year). But even someone with three years experience running an intermediate bond fund can look better on paper than my 15 running money markets.
Last year I would have said I’d be likely to try to get something in investor relations with a structured finance company that needs good money market contacts. But most of those issuers have blown themselves up, so that’s sort of out.
Well… at least the weather is getting warmer and I pulled my sailing dinghy out of winter storage last week. Still a bit chilly in the Sound, but I should have plenty of time to sail after the exam.
Oh… and thanks for asking.
 
A prompt reply from Schweser confirms their error:
Dear Candidate,
Thank you for choosing Schweser and thank you for pointing this out. I will change it.
 
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