ADM 3351 Lecture Notes - Lecture 5: Cash Flow, Call Option, Risk Measure

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Risk factors affecting an index can be classified into two types: systematic risk factors and nonsystematic risk factors. Systematic risk factors can be divided into two categories: term structure risk factors and nonterm structure risk factors. Nonterm structure risk factors include sector risk, quality risk, optionality risk, coupon risk, mbs sector risk, mbs volatility risk, and mbs prepayment risk. Sector risk is the risk associated with exposure to the sectors of the benchmark index. Quality risk is the risk associated with exposure to the credit rating of the securities in the benchmark index. Optionality risk is the risk associated with an adverse impact on the embedded options of the securities in the benchmark index. Coupon risk is the exposure of the securities in the benchmark index to different coupon rates. Mbs sector risk, mbs volatility risk, and mbs prepayment risk are associated with the investing in residential mortgage pass-through securities.

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