SoA6, Mortgage Negative Convexity

[OT]

SoA6, Negative Convexity
HBOFIS, Ch 24, Mortgages and Overview of Mortgage-Backed Securities,
Pre-payment Risk,

“The investor in a mortgage is exposed to negative convexity when interest rates decline below the loan’s contract rate.” from page 561.

What do they mean that the investor is exposed to negative convexity? I am thinking that the x-axis is interest rates and y-axis is value of security/mortgage. As environmental interest rates decline, the value of the security/mortgage goes up until it (environmental interest rates ) reaches the mortgage interest/contract rate. From this point the change in value takes on a negative convexity (as interest rates decrease) -- not necessarily negative slope, though -- because the it will likely be called/prepaid at par.

Any comments or questions would be greatly appreciated.

<font size=-1>[ This Message was edited by: OT on 2001-12-27 16:32 ]</font>