An Interest Only Strip holder benefits from higher interest rates than expected prepayments, and a Principal Only Strip holder benefits from lower than expected prepayments and interest rates.
What is the difference between Principal Only (PO) Strips and Interest Only (IO) Strips?
The holders of PO strips benefit when the investment period is cut short because they will only ever see the face value of their investment.
In order for the mortgage holders in the pool to continue making payments (including interest) on their current loan rather than attempting to refinance into a new one, they want to see interest rates at the same level or higher.
Therefore, A principal only strip holder benefits from lower than anticipated prepayments and interest rates, while an interest only strip holder benefits from higher interest rates than anticipated prepayments.
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