(a) (2 marks) In your own words, explain what is meant by prepayment risk.

(b) Answer true or false to the following statements:

(i) (1 mark) A collateralized mortgage obligation (CMO) provides protection against credit risk.

(ii) (1 mark) Consider an Interest-Only (IO) security. If interest rates go down, the discount rate for valuing the cashflows to the IO security-holders goes down and the price of the IO security will go up.

(iii) (1 mark) Consider a Principal-Only (PO) security. If interest rates go down, the discount rate for valuing the cashflows to the PO security-holders goes down and the price of the PO security will go up.