Final answer:
The least accurate statement is that fixed-rate bonds are not subject to interest rate risk; both MBSs and fixed-rate bonds are affected by changes in interest rates. MBSs pay monthly, are subject to prepayment risk, and unlike fixed-rate bonds, their principal repayment can vary due to early repayments. If inflation drops, ARM payments may decrease, while fixed-rate mortgage payments remain unchanged. The correct answer is option (c)
Step-by-step explanation:
The statement regarding the differences between mortgage-backed securities (MBSs) and fixed-rate bonds that is least accurate is: c. MBSs are subject to interest rate risk while fixed-rate bonds are not. Both MBSs and fixed-rate bonds are subject to interest rate risk. Interest rate risk is the risk that the value of a fixed-income security will decline due to rising interest rates. As interest rates rise, the present value of a security's future cash flows, which are fixed, declines, thereby reducing the security's value.
MBSs pay coupons and principal monthly, which contrasts with the typical structure of fixed-rate bonds that pay coupons semi-annually and principal at maturity. One of the unique aspects of MBSs is that they are subject to prepayment risk, meaning that if homeowners refinance or sell their homes, the principal may be repaid earlier than expected, affecting the returns for investors. Fixed-rate bonds do not have this risk as they have a defined maturity date and repayment schedule.
Considering the market dynamics, if inflation falls unexpectedly by 3%, homeowners with an adjustable-rate mortgage would likely benefit. An adjustable-rate mortgage (ARM) has an interest rate that fluctuates with market rates, so a decrease in inflation often leads to lower interest rates, which would reduce the payments for those with ARMs. Whereas homeowners with a fixed-rate mortgage wouldn't experience any immediate change in their payments as their rates are locked in regardless of market fluctuations.