I have a hard time wrapping myself around thoses concepts in fixed income so here is my understanding:
Contraction risk: Risk of increasing interest rate which will prompt refinancing and prepayment risk
Extension risk: Risk of decreasing interest rate which will reduce prepayment risk.
Support tranches: Absord prepayment risk and extention risk (how can absord both risk at the same time?)
Junior vs senior tranches: Segment a CMO so that investor can choose their their favorite tranches. Senior tranche have less default risk but trade off is more prepayment risk. Junior tranches have more default risk but less contraction risk.
In general senior tranches have higher spread, seems to me that senior tranches are better than junior tranches. Senior tranches must be traded at a premium versus junior tranches…
Please feel free to correct my analysis.
Thanks and good luck everyone.