Which of the following is referred to as a sequential-pay CMO? A sequential-pay CMO is structured so that each class of bond: A) receives prepayments on a sequential pro-rata basis. B) is retired sequentially. C) has different credit risk.
B, even though it also has the word sequential in the answer
B
Correct. But doesn’t it also has different credit risk?
agency cmo has with very very very little credit risk - they are all securities back from fannie/freddie/gannie mbs.
but it doesn’t say that those are agency CMO
@boston: sequential pay structures are designed to distribute contraction/extension risk. Senior/sub structures are used to distribute credit risk.
adavydov7 Wrote: ------------------------------------------------------- > @boston: sequential pay structures are designed to > distribute contraction/extension risk. Senior/sub > structures are used to distribute credit risk. I’m not sure this is entirely correct according to what I read in CFAI text last night. I don’t have the book with me at the moment, but I have the flash cards I made. Although sequential pay does have the side effect of reducing contraction/extension AND credit risk, its main purpose is to offer issues of varying average life. The reduced risks are really a result of being a shorter life issue. My card says: Sr/Sub - distributes prepayment risk Multiple Classes (A,B,C) - Distributes Credit Risk Sequential Pay - provides a variety of average life Anyone have a different take on this?
they don’t have different credit risk. Tranche A will have as much credit risk as B becuase sequencing deals with prepayment and prepayment risk, not losses. Credit risk is only re-distributed by senior/junior tranche structure. (i.e. more junior tranches will absorb initial losses, thus have more credit risk)
@dlpicket: wrong on both Sr/Sub and Sequential, my source is Vol. 5 of the CFAI texts pgs. 403-404, I quote: right after the discussion of sequential pay tranches “The reason for the creation of the structure just described is to redistribute prepayment risk among different bond classes.” this is the first sentence of the last paragraph on pg. 403. right after the discussion of senior/sub pay tranches “The purpose of this structure is to redistribute the credit risk” middle of page 404 between the two tables. Better correct those note cards;)
Good Call. I’ll check these when I get home, but I based this on a question in the end of CFAI chapter. I had it memorized the way you just said, but somehow managed to get that Q wrong.