I put IFL, but correct answer is Tranche A.
what gets me is that FL and IFL were not even in the Schweser books (pls correct me if im wrong if anyone finds them)
srwarrington, if its an easy topic then please cite CFAI text for “Contraction Risk” and Accrual Tranche.
jsjrcomcast, can you please let me know where you are getting your WAL info from?
jsjrcomcast Wrote: ------------------------------------------------------- > srwarrington, if its an easy topic then please > cite CFAI text for “Contraction Risk” and Accrual > Tranche. Contraction risk refers to prepayments in excess of what was planned. When rates go lower and such. Accrual tranche is a part sequential pay bond that is paid last and in most cases does not receive interest payments. These interest payments are added onto the prinicipal. The summary is Contract risk is most present in the A tranch gets smaller as you move down, and extension risk is largest in the Z tranch gets smaller as you move up. I can totally see where someone just simply didnt read or cocentrate on this topic, but I do think the material is straightforward once you do.
My point is where is the definition of contraction risk? I work in the business (i threw up a little in my mouth for saying that) and to us contraction risk is the cost to your position of early prepay. By that definition, the accrual bond has the highest risk. And i get that its not market slang that is important, its CFAI. I just cannot find the definition in CFAI. If it was straightforward as you claim, there would be a definition and exaplantion. For example, I got the vol question wrong and I could go back to the text and prove to myself that I was wrong.
Hmm… I think you may be looking at contraction risk incorrectly because Tranche A still has the most risk in a sequential pay bond by your definition. Contraction Risk ultimately means the risk that you will not receive the ASSUMED interest payments. This happens when rates go down, so even if you re-invest the principal you received it will be at a lower rate. Accrual tranche has less contraction risk because their principal won’t be touched until last. That clear it up any better? I totally forget how CFAI presents this topic by now, but that is how my brain summed it up in my head. I’m pretty sure my concept is accurate…
OK, lets END DISCUSSION. Good luck on your results!