what is the effect of increased rates on the duration of a fixed-rate bond? Or a fixed rate MBS.
I feel like for an MBS product if rates decreased it would decrease duration because more people would refinance their loans and since duration is a weighted-average of the life of the security it would decrease the time it took to pay-back the loan.
But if rates increased, it would have minimal impact on duration?
I presume that you’re asking about effective duration.
If so, for a fixed-rate, option-free bond, as YTM increases, effective duration decreases and as YTM decreases, effective duration increases.
For an MBS, it depends on whether you’re above or below the point where convexity changes from negative to positive. Below that point, an increase in yield leads to an increase in effective duration and a decrease in yield leads to a decrease in effective duration: the opposite of a fixed-rate, option-free bond. Above that point, the MBS acts much like a fixed-rate, option-free bond: as YTM increases, effective duration decreases and as YTM decreases, effective duration increases.
Brilliant. Thanks!
My pleasure.