What best describes why mortgage funds generally have less sensitivity to changes in interest rates than bond funds?

Mortgage funds have lower interest rate sensitivity primarily because of the structure of mortgage payments. Mortgages require monthly payments of both principal and interest. This regular return of principal shortens the fund's weighted-average term to maturity, also known as duration. A shorter duration means the fund's value is less sensitive to fluctuations in interest rates compared to a bond fund, where principal is typically repaid in a lump sum at maturity.

A. While some funds may hold these securities, the fundamental reason for lower sensitivity lies in the cash flow structure of the core mortgage assets.

C. Diversification reduces specific (unsystematic) risk related to individual defaults, not systematic interest rate risk that affects the entire market.

D. Mortgage insurance protects against credit risk (default risk), not interest rate risk, which is the risk of value change due to interest rate movements.

1. Canadian Securities Institute. (2023). Investment Funds in Canada Course Textbook. Chapter 5: Types of Investment Funds, Section "Mortgage Funds".

2. Fabozzi, F. J. (2015). The Handbook of Fixed Income Securities (9th ed.). McGraw-Hill Education. Chapter 25: Mortgage-Backed Securities.