CFA CFA Level 3 Negative duration and positive duration positions in swaps and MBS

Negative duration and positive duration positions in swaps and MBS

  • This topic has 4 replies, 3 voices, and was last updated Apr-17 by adossa3.
  • Author
    Posts
    • adossa3
      Participant
      Up
      26
      Down

      Hi there,

      very Confused about negative and positive duration positions where they show up in 1) Risk Mgt of swap strategies and in 2) MBS…:-(

      Negative duration: does it mean to ‘reduce duration’ ? – or hold a position that moves directly with interest rates – eg wanting to add a negative duration position like a pay-fixed swap, receive floating to the fixed income portfolio: pay fixed side -0.75 and receive floating side + 0.125, = -0.625
      does this mean simply that a fixed rate borrower gains (+) when int rates rise (+) ?

      Positive duration: does it mean to ‘increase duration’ ? – or hold a position that moves inversely to int rates – eg wanting to add a positive duration position like a pay-floating -0.125 and receive-fixed +0.75, swap, to the fixed income portfolio = +0.625
      Does this simply mean that a floating rate borrower gains (+) when int rates fall, (neg) ?

      In MBSs: Principal Only notes have a positive duration and Interest-Only notes have a negative duration.

      I thought that POs dur incr, as when int rates rise, prepayments slower, and POs life/duration gets longer, bad, so their price falls, as underlying mortgage pool duration longer: does ‘positive’ mean a longer life of the PO ?

      IOs have negative duration as when int rates fall, faster prepymts terminate the underlying interest-only pool, and the value of the IO falls – what is the negative position, the shorter life of the IO ?

      Head is swimming…………..feel faint 😉 !!

      Thanks v much for all the moral and mental support !

    • Sophie Macon
      Keymaster
      Up
      3
      Down

      Hi @adossa3 – I only just saw this. Give me a little time and will get back to you asap. 🙂

    • Zee Tan
      Keymaster
      Up
      3
      Down

      Hi @adossa3 – positive duration definitely means a position or valuation that moves inversely to interest rates, and negative duration meaning moving directly with interest rates.

      For principal-only and interest-only MBS, here’s the conceptual reasoning:

      • Declining interest rates increase PO repayment speed, lowering the discount rate and increasing the PO price. Hence +ve duration.
      • Declining interest rates mean that repayments speed up, so there’s less interest paid (lower principal, plus lower interest rates), so IO value decreases. Hence -ve duration.

      Hope that helps!

    • Sophie Macon
      Keymaster
      Up
      4
      Down

      And @zee beat me to it! 🙂 Hope his answer helps!

    • adossa3
      Participant
      Up
      5
      Down

      Thanks very much Zee! Awesome, was so confused. 🙂
      want to learn formulas over the next week and go over the stuff am finding hard. Extr tired today and progress is v slow….Thank you, thank you thank you Zee and Sophie for the moral support also !

Viewing 4 reply threads
  • You must be logged in to reply to this topic.