# Block 011 — MBS-Treasury basis / prepayment risk

**Status:** ● done (main material complete; cold-recall on prior block done in Session 16; **opened and closed in Session 17, 2026-07-06**)
**Phase:** Phase 1 (Rates)

## Topic scope

How MBS duration extends when rates rally. Why MBS underperform Treasuries in steepener rallies. Negative convexity channel. MBS-Treasury basis trade.

## Plan

**Prerequisite:** Block 00a (rubric), Block 00b (anti-patterns). MBS basis trades have a specific narrative-without-pricing anti-pattern risk.

### Pre-read (assigned 2026-07-04, Session 15 close)

- **Fannie Mae MBS Basics** white paper — agency MBS pass-through structure, pool factor, WAC, WAM, PSA prepayment benchmark (~20 min, orientation)
- **SIFMA MBS primer** — same content from the trade-association angle (~10 min, vocabulary)
- **Hull Ch. 24 (Securitization)** skim — MBS as a securitized product, just for vocabulary (~10 min)
- Skip: detailed CMO/REMIC tranche mechanics (Phase 2 territory if reached), non-agency MBS (different risk profile, not Block 011 scope)

**Pre-read compliance (2026-07-05, Session 16):** User confirmed pre-reads complete before Session 16 open. Cold-recall probe on Block 010 Working items performed instead of opening Block 011 main material; full MBS material deferred to next session.

## Session history

### 2026-07-05 — Session 16 (Block 011 pre-block — cold-recall probe on Block 010 only)

**Pre-block activity:** 4 plain-text probes on Block 010 Working items (vol surface / Black's model / rate-cut extraction / ZN surface rep).

**Probe outcomes:**
- Q1 (vol surface, RR/BF): Working+ on both 1a (RR) and 1b (BF). Precision point: dealer-flow read phrasing — "payers are being bought, dealers short payer / long receiver, rally-hedge demand" rather than collapsed "dealers are short."
- Q2 (Black's model): Working+ on limitation (lognormal → no negative rates, no fat tails). User initially gave "simplistic volatility" surface read; mechanism filled in (lognormal distribution assumption, structurally rules out negative rates). Trade-off retaught: Black gives arbitrageable pricing framework but cannot reprice vol surface shifts — separate vol regime read needed.
- Q3 (rate-cut probability extraction): User did not retain the four-layer chain cold. Full re-teach. Key new concepts added: (1) risk-neutral vs real-world probability (5-10bp gap = risk premium, itself tradeable); (2) cross-asset transmission (real-yield channel for gold, duration for TLT, USD for DXY, risk-on for equities); (3) annual vol vs single-meeting event mismatch (the 65bp is continuous annual variance, not single-meeting discrete move). Reconstruction at end of probe: Working+ with the risk-neutral precision point to lock in.
- Q4 (ZN surface rep, vol-of-vol-in-motion): Working+ on both parts. High-leverage insight nailed: 5.4% one-day move in vol IS the vol-of-vol signal (size of vol move reveals vol regime). No new concept; the retention is solid.

**Net cold-recall outcome:** All 4 Block 010 items at Working+. No regressions. Carrying all 4 to Block 015 W27 verification per plan.

**Card drafts:** 17 forward + 5 reverse scenario cards drafted to scratch at `/tmp/hermes-mbs-cold-recall-cards.md`. User directive: push at end of next session (after Block 011 main material), not now. Reverse cards added after forward per user directive.

**Status transitions:** None (all 4 items remain Working, no upgrades to Strong, no regressions to Weak).

**Anki cards generated:** 0 this session (deferred to next session per user directive).

**Block status:** Block 011 still `○ queued` — pre-reads complete, cold-recall on prior block done, main material not yet started. Will open with pre-block probes (00-05 prefix per pre-read convention) on MBS pass-through structure + pool factor + WAC + WAM + PSA benchmark.

## Carry-forward to next block

### Inherited from Block 010 (Session 15)
- 4 new Working items re-probed at Block 015 W27 verification: vol surface (RR/BF/vol-of-vol), Black's model + limitation, rate-cut probability extraction, ZN surface rep
- Resource node at `~/Obsidian-Macro/03-research/deep/volatility-trading-resources.md` is the canonical "where to look up vol data" reference for the rest of the program

### Inherited from Session 16 (pre-block cold-recall)
- 17 forward + 5 reverse cold-recall cards pushed end of Session 16 (Block 011 cold-recall tags). Lock-in precision points: (1) dealer-flow read phrasing for RR, (2) lognormal mechanism (not "simplistic"), (3) risk-neutral vs real-world probability in the cut-probability chain
- vol-of-vol-in-motion (size of vol move = vol-of-vol signal)
- cross-asset transmission logic (FedWatch = cut, swaption surface = cross-asset response distribution)

### Session 17 (2026-07-06) — Block 011 main material + close

**Pre-block probes (5 vocabulary items + 1 transition probe):** All 5 vocabulary items (pass-through structure, pool factor, WAC, WAM, PSA benchmark) at Working+. Two precision landings on the way: (1) pool factor is current-outstanding / original-face (stock measure, not flow); (2) WAC drift is selective by coupon (high-coupon paper prepays first in rally, low-coupon paper prepays last in selloff — adverse selection in payoffs is the observable mechanism of negative convexity).

**Main material delivered (4 concepts + 1 live-data probe):**
- **Pass-through vs CMO structure:** Pass-through = single class, pro-rata after servicer (~25bp) and agency g-fee (~50-100bp). CMO = multi-class, waterfall. The "tranching" framing from user answer is CMO territory, not pass-through. Agency guarantee covers borrower default (not originator/issuer).
- **Negative convexity mechanism:** WAM-extends-on-rally + WAC-drift-selection. Compared to Treasury: MBS underperforms in *both* directions (rally and selloff). Negative convexity = price underperforms Treasury in both directions.
- **MBS-Treasury basis trade:** DV01-matched long MBS / short Treasury. 30y UMBS TBA at ~5.58% current coupon vs 30y UST at 4.97% = +61bp gross secondary spread. Net basis negative (option-overpriced). Hedge ratio ~2.3x MBS face to Treasury face. Net carry ~30-50bp annualized. Convexity-adjusted breakeven = +200 PSA over hold period (refi wave doubling prepay speed).
- **PSA mechanics:** 100 PSA = 6% CPR baseline. Month 1-30 ramp = 0.2%/month linear (seasoning). Month 30+ = flat 6% CPR. 300+ PSA = refi wave. 500+ PSA = aggressive. 800+ PSA = peak refi.
- **Live data probe (Q8):** Verified 30y mortgage 6.43% (Freddie PMMS 2026-07-02), 10y UST 4.48% / 30y UST 4.97% (FRED H.15 2026-07-01). Current coupon ~5.58% (mortgage − g-fee − servicing − TBA discount margin). User's 5.0% data read was correct for off-the-run paper but not for current production TBA. PSA speed estimate: current 5.5% coupon pool running ~200-250 PSA (refi-incentivized but not screaming refi wave). Breakeven: mortgage rates need to drop to ~5.5% (100bp drop) to trigger material PSA acceleration. User's 50bp answer in (d) was directionally right but units were wrong — breakeven is in PSA-speed terms, not yield terms; yield-equivalent version is 30-50bp underperformance vs Treasury before carry is wiped out.

**Status transitions:**
- **Rates — MBS pass-through structure:** NEW Untested → **Working+** (re-probe Block 015 W27 verification)
- **Rates — negative convexity mechanism:** NEW Untested → **Working** (re-probe Block 015)
- **Rates — MBS-Treasury basis trade:** NEW Untested → **Working** (re-probe Block 015; live-data exercise locked the hedge-ratio + breakeven framework)
- **Rates — PSA prepayment mechanics:** NEW Untested → **Working** (re-probe Block 015; ramp + refi-wave thresholds locked)

**Anki cards generated (Session 17):** 4 forward + 2 reverse = 6 atomic cards on the lock-in sentences. Pushed via AnkiConnect + synced. Tags: `block-011 mbs negative-convexity psa-mechanics basis-trade` (forward) + `block-011 mbs negative-convexity basis-trade reverse` (reverse). Forward note IDs: 1783338119037 → 1783338119380. Reverse note IDs: 1783338119492 → 1783338119606.

**Pre-read for Block 012 (assigned at this session close, per protocol):**
- **Hull Ch. 7 (Swaps) — SOFR-OIS section** (~15 min, orientation on OIS discount curve and SOFR construction)
- **Fed ARRC transition docs** (Alternative Reference Rates Committee) (~10 min, institutional vocab on the LIBOR → SOFR transition)
- **Skip:** detailed 3-month SOFR futures (SR3) mechanics — Block 058 (Phase 2 instrument dossier)

**Pointer:** `_meta/current-block.md` updated at end of session. Block 011 → done. Block 012 → next.

### Post-block practice artifact (added 2026-07-06)

`~/Obsidian-Macro/03-research/deep/daily-mbs-routine.md` — 5-minute daily routine paralleling the Block 010 vol routine. Five numbers (PMMS 30y, 30y UST, gross spread, MBA refi share, current coupon), one exercise, one decision. Daily MBS signal practice to internalize the prepay-and-basis pulse. Companion to `daily-vol-routine.md` — run them back-to-back (vol first, then MBS) for a complete 10-minute rates-microstructure read.