Expert: Doug Ingram - 2/18/2005

Question
Hi Doug.  I have a question for you on Principal Only (PO) CMOs and negative duration.  I know that POs increase in value as rates decline because the principal payments will rush in as refinancing occurs.  Given that dynamic, could you help me understand why I am reading that POs have negative durations in an environment where rates are dropping?

Mark

Answer
As far as I know, the only securities that can have negative duration are IOs (interest only).  That's because you own no principal and may lose all your investment on a quick prepayment.  
A security with any future principal flows would have positive duration and WAL.
However, if rates go down - duration does decrease, but that's not the same as negative duration.

BTW - When I clicked the question - it said I had already answered.  So, I don't know what the other answer was - maybe a blank?

If the question has more detail, I'll look into it.