I was going thru the CMO stuff in CFAI book. Exhibit 16 in reading 58 illustrates a PAC structure with six PAC tranches and one support tranch Tranche Par amount coupon rate P-A $85mm 7.5% P-B 8mm 7.5% . . . S 156.2mm 7.5% The explanatory material says the support tranches provide protection for both the $85mm of PAC-A tranche and $93mm of PAC-B. 1-How comes PAC-B is of $93mm? 2-Why is the same coupon offered on PAC and support tranches?..I thought support tranche eas supposed to have a higher coupon… Would be great if anyone can help me out…
PAC-B could be of 93M but I suspect that there is a typo related to the 85+8=93. I don’t see a coupon given here, but unless the support tranches come with Rolex watches or something they should have higher coupons.
about the support tranche – keep in mind you have to be rewarded for your risk, and that isnt just coupon – its yield. lets say the PAC and the support both have 7.5 coupons, but the price of the pac is 101, and the price of the support is 80. think of the yield you would have… it would be like 10% or more priced at 80. thats where the compensation comes from for this particular structure
^ that’s right - i was (probably incorrectly) assuming they were both selling at par.
Yeah thats true that PAC-B tranche could be of $93mm if seen on a standalone basis…but confusion in this question resulted from inconsistency in the amount of tranche stated in table and explanation…Well I can assume that its a typo… Thanks for the comments…