hi guys, just confused.
no unfortunately prepayment includes both contraction n extension risk
think of prepayment risk as “rate of prepayment risk” if rate of prepmt is higher than expected ->contraction risk if rate of prepmt is lower than expected -> extension risk
Contraction = Risk that prepayments increase when your reinvestment opportunity sucks Extension = Risk that prepayments decrease when your reinvestment opportunity is great So, like pimp said, Prepayment = Extension and Contraction risks.
Prepayment risk is the uncertainty regarding the timing of prepayments given a number of factors, including the path of interest rates and incentive for refinancing. Should prepayments exceed expectation, the investment is subject to contraction risk (e.g. principal is repaid faster than expected and there is reinvestment risk). Extension risk is the flip-side whereby prepayments come in at a rate lower than expected.
thanks! I fell into chaos:(
i noticed that schweser screws this up in the secret sauce. take a look at page 153 if you have the secret sauce. second bullet, last line says “The accrual bond absorbs most of the prepayment risk in a sequential pay structure.” well technically theyre right–the accrual tranche has the most extension risk which is part of prepayment risk. but i feel like the more correct answer is extension risk. does anyone disagree?
the show NY Wrote: ------------------------------------------------------- > i noticed that schweser screws this up in the > secret sauce. take a look at page 153 if you have > the secret sauce. > > second bullet, last line says “The accrual bond > absorbs most of the prepayment risk in a > sequential pay structure.” > > well technically theyre right–the accrual tranche > has the most extension risk which is part of > prepayment risk. but i feel like the more correct > answer is extension risk. > > does anyone disagree? The accrual absorbs the prepayments and has the most extension risk.
bpdulog Wrote: ------------------------------------------------------- > the show NY Wrote: > -------------------------------------------------- > ----- > > i noticed that schweser screws this up in the > > secret sauce. take a look at page 153 if you > have > > the secret sauce. > > > > second bullet, last line says “The accrual bond > > absorbs most of the prepayment risk in a > > sequential pay structure.” > > > > well technically theyre right–the accrual > tranche > > has the most extension risk which is part of > > prepayment risk. but i feel like the more > correct > > answer is extension risk. > > > > does anyone disagree? > > > The accrual absorbs the prepayments and has the > most extension risk. exactamundo and this is because its interest and principal payment go o the other tranches i.e it gets paid last
right–so when they call it “prepayment risk” am i supposed to guess which type? i always assumed for some reason that if it just says prepayment risk with no specifics then its contraction risk by default (in level 1 we were taught that prepayment risk is just contraction risk) so thats why i had issue with the line.
can u define what “absorbing prepayment risk” means? the accrual tranche doesnt get interest or prinicpal till the end so it seems to be “deflecting” the prepayment risk by not being paid early–not “absorbing”
Prepayment risk isthe risk of deviating from the expeted prepayments. It could lead to either contraction or extension.
right. so why is it correct to say, as secret sauce does on page 153, that the accrual tranche “absorbs” the prepayment risk. the accrual tranche gets paid at the very end, so it has the least amount of prepayment risk (or more accurately, the least amount of contraction risk and the most extension risk). i am not follow the “absorbing prepayment risk” line.
when prepayments happen - and all the other Support tranches have gone - with its bucket of Interest Accrued + the original par value the Accrual bond started out with - would the Z-Tranche now start to absorb prepayments?
yes but at the very end, so technically yes it absorbs it all at the end.