Question #3

B. putable

C. option-free. Bill Woods, CFA, is a portfolio manager for Matrix Securities Fund, a closed-end bond fund that invests in U.S. Treasuries, mortgage-backed securities (MBS), asset-backed securities (ABS), and MBS derivatives. The fund has assets of approximately $400 million, has a current stock price of $14.50 and a net asset value (NAV) of $16.00. Woods is a member of a four person investment team that is responsible for all aspects of managing the portfolio, including interest rate forecasting, performing basic financial analysis and valuation of the portfolio, and selecting appropriate investments for Matrix. His expertise is in the analysis and valuation of MBS and ABS. The fund pays a $0.12 monthly dividend that is paid from current income. The basic operating strategy of Matrix is to leverage its capital by investing in fixed income securities, and then financing those assets through repurchase agreements. Matrix then earns the spread between the net coupon of the underlying assets and the cost to finance the asset. Therefore, when evaluating a security for investment, it is critical that Matrix can be reasonably assured that it will earn a positive spread. During the course of his analysis, Woods utilizes several methodologies to evaluate current portfolio holdings and potential investments. Valuation methods he uses include nominal spreads, Z-spreads, and option-adjusted spreads (OAS). There is ongoing debate among the investment team as to the merits and shortcomings of each of the methods. Woods believes that the OAS method is by far a superior tool in all circumstances, while his fellow portfolio manager, Yuri Ackerman, feels that each of the methods can at times serve a useful purpose. Wood and Ackerman's current discussion involves two similar FNMA adjustable-rate mortgage (ARM) securities Wood is considering purchasing. Both ARM "A" and ARM "B" are indexed off of 6-month LIBOR, are new production, and have similar net coupons. Select Financial Information: ARM Net Coupon WAM Nominal Spread OAS (bps) Z-spread (bps) A 6.27% 360 81 98 135 B 6.41% 358 95 116 129 Woods recommends that Matrix purchase ARM "A" with the 6.27% net coupon. He has based his conclusion on the calculated OAS of the securities, which he believes indicates that ARM "A" is the cheaper of the two securities. Ackerman disagrees with Woods, arguing that OAS