Calculation Of IO tranche

CFA Level II
#1

I am struggling with the calculation of Interest only tranche.Please help me with question 28 pg 475 Rdg 48

#2

Although I don’t have a copy of the curriculum at hand, the calculation of the payment on an IO tranche should be pretty straightforward: the coupon rate times the remaining principle balance (less the servicing fee).

#3

The question is as follows

Consider the following CMO structure backed by 8% collateral

Tranche par amount coupon rate

A 400000000 6.25

B 200000000 6.75

C 225000000 7.50

D 175000000 7.75

SUPPOSE the structurer of this CMO wants to create a notional IO trance with a coupon rate of 8%. Calculate the notional IO tranche

#4

My understanding regarding the process is as follows

The first tranche A already has an interest rate of 6.25% but the required is 8% therefore we take the diffrence in the rates and calculate the extra principal we need to bridge the gap.

We do this for all the tranches and add all the extra principal required to get the IO "s notional principal .

DO you think by process is correct?

#5

This is a pretty bad question. Your process would be correct assuming:

  1. These are the only tranches (reasonable to assume)

  2. There is no servicing spread (unreasonable).

The question should preferably specify that:

Using a collateral of $x with an 8% coupon rate, the following tranches were created. Any excess coupon would be used to create an IO tranche. Compute the notional principal of the IO tranche.