Why would a pass-through with a WAM of 350 months be an unattractive investment for a savings and loan association?
What will be an ideal response?
Prepayment risk makes pass-through securities unattractive for certain financial institutions to hold from an asset-liability perspective. Thrifts and commercial banks want to lock in a spread over their cost of funds. Their funds are raised on a short-term basis. If they invest in fixed-rate pass-through securities with a WAM of 350 months (over 29 years), they will be mismatched because a pass-through is a longer term security. In particular, a savings and loan association and other depository institutions are exposed to extension risk when they invest in pass-through securities. When interest rates rise investors will not refinance their homes.
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