What type of prepayment protection is afforded a reverse TAC bond?
What will be an ideal response?
If mortgage rates rise, the price of any bond will decline. But pass-throughs will decline more because the higher rates will tend to slow down the rate of prepayment. This is just the time when investors want prepayments to speed up so that they can reinvest the prepayments at the higher market interest rate. This adverse consequence of rising mortgage rates is called extension risk. Some institutional investors are interested in protection against extension risk but are willing to accept contraction risk. This is the opposite protection from that sought by the buyers of TAC bonds. The structures created to provide such protection are referred to as reverse TAC bonds.
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Indicate whether the statement is true or false