I understand that as interest rates go down, homeowners are likely to prepay and thus, holding an MBS is worse than holding a regular treasury bond. However, I am trying to understand why it is worse to hold an MBS than a regular treasury bond when interest rates rise. In my mind, an MBS holder is short a call option on bond price. However, as bond prices go down (yields rise), that call becomes worth less and less. I don't see how this hurts the MBS holder.
Also, I am trying to understand how increases in housing prices would cause an increase in prepayments. If the borrower takes out additional equity, isn't that the opposite of a prepayment?
Also, I am trying to understand how increases in housing prices would cause an increase in prepayments. If the borrower takes out additional equity, isn't that the opposite of a prepayment?