Another MBS Q

CFA Level II
#1

Can someone please explain this to me: A PAC bond with a very narrow PAC window resembles a corporate bond with a bullet payment. Thanks

#2

there would only be 1 payment i.e. with a narrow collar, the prepayment speed assumption will only force the trance to make a single payment

#3

I just don’t get it. So a narrow band means exactly what, the PAC tranche will prob get busted faster? So you are saying once the support tranches are finished trying to maintain the tight band all prepayments will hit the PAC tranche. Also what exactly is the definition is a bond with a bullet payment? Is a Zero Coupon one?

#4

A PAC Window is where its principal gets paid. So the PAC Tranche gets paid off faster. If this is the case, it is not a bad thing. The narrow PAC tranche window is by design, and thus has been priced. A PAC gets busted - when it has no support tranches to take the additional prepayments that come in, and is forced to absorb them and as a result, the PAC Tranche contracts, which is bad. A bond with a bullet structure is very similar to a zero-coupon bond.

#5

I like to think of it this way: Most CMO PAC structures have multiple PAC classes; ie PAC 1, PAC 2, PAC 3…PAC n. These all have different “windows” as to when the principle is payed off, and are generally structured so that the principle of each is payed in a sequential order. If you are invested in say PAC 10 and each PAC window before and including PAC 10 is for 1 year each, then the principle for your PAC tranche will be payed off completely in year 10 and only the coupon pmts will be paid (for this PAC class) in years 1-9. This looks exactly like a bullet bond.

#6

Thanks also FYI I found a really good explanation of this: “The PAC investor is scheduled to receive fixed principal payments (the PAC “schedule”) over a predetermined period of time (the PAC “window”) through a range of prepayment scenarios (the PAC “band”). The schedule will be met only if the underlying mortgage-related collateral prepays at a constant rate within the range assumed for the structuring of the PAC.” I was confusing the PAC band with the PAC window. ANyway thanks.