GARP.2012.P2.19. Which of the following statements about the impact of rising home prices on mortg

[bgriggs2]

Hi David,

Which of the following statements about the impact of rising home prices on
mortgages is incorrect?

a.Negative convexity limits mortgage price appreciation.
b.Higher prepayment penalties increase the payout to banks in the event
mortgagors refinance to “cash out” on their equity.
c.The expected life of a mortgage with a low teaser rate increases as the size of the
step-up rate increases.
d.Expected losses decrease as the value of mortgage collateral increases.
I understand that c. is incorrect here. I also know that a. Negative convexity limits mortgage price appreciation, is in fact true. However, I am struggling to make the connection as to why this would impact rising home prices? Thanks

 

[David Harper CFA FRM]

Hi bgriggs,

FYI, there is a little more color, at the source forum, on correct choice (C): http://forum.bionicturtle.com/threads/p2-19-current.5075/

In regard to (A), I agree with you. Frankly, it looks like sloppy question-writing (I am not a huge fan of the 2012 samples). They could arguably have in common lower rates: lower rates would tend to both contribute to higher home prices (buy increasing/shifting demand via loan availability) and the negative convexity exhibits at lower rates. But I don't perceive that's going on. Rather, I think (A) is just inserted because it is a common, true statement. Thanks,