Key Risks Summary

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Chapters in this video

  1. 0:00 Prepayment risk: the falling-rate storm
  2. 2:20 Extension risk: the rising-rate drought
  3. 4:26 CDO credit risk: cash flows top-down, losses bottom-up
  4. 5:04 Hedge fund liquidity and transparency risk
  5. 6:12 Rapid-fire exam recap

What this video covers

  • Which CMO tranches absorb prepayment (contraction) risk and which stay protected within a prepayment band
  • Why interest-only (IO) strips and principal-only (PO) strips react in opposite directions when prepayment speeds change
  • How extension risk flips the damage to different tranches when rates rise and borrowers stop refinancing
  • The exact exam trap: government-sponsored enterprise (GSE) guarantees cover defaults, not timing of prepayments
  • Why credit risk flows bottom-up in CDOs (equity tranches eat losses first) while cash flows pay top-down (senior tranches get paid first)
  • How lock-up periods and lack of exchange trading combine to create liquidity risk for hedge fund investors
  • Why transparency risk is uniquely high for hedge funds compared to registered investment companies like mutual funds and exchange-traded funds (ETFs)

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