it says the correct answer is C - because an accrual tranche has no effect on prepayment risk. HOW THE *BEEP* is that possible?
I got that one wrong too, I couldn’t decide between that one or the correct answer and ended up picking the wrong one. I re-read the section last night, and prepayment risk is affected to the extent that it is redistributed to subordinate tranches such as the accrual tranche.
in a sequential pay setup, the accrual tranche only protects against extension risk. Its the PAC that provides extension and contraction protection.
so I guess unless it protects against both extension and contraction, its not considered a true prepayment risk?
aladak, i know we started to discussing this one last night. i looked it up in the official CFAI curriculum, and it plainly states that Prepayment risk is made up of contraction AND extension risk.
nerd is right…