I have a hypothetical question regarding the equity tranche in a CMO structure. If an equity tranche is receiving the residual cash flow after the payment of all other tranches and there are little to no defaults or signficant waves of prepayment for the first 2 years, but then the equity tranche stops receiving cash flows in year 3 (just barely), could the situation reverse itself and the CMO once again have excess cash flows to pay to the equity tranche or is the equity tranche dead? The CFA Level II text only has a small foot note about the equity tranche.
Not sure, but in general, once the flow income stops to the equity tranche, that’s it. In this environment, there may be mortgages that stop paying and then start paying again through mortgage adjustments, or people who fall behind and then make up payments. My guess is that all other tranches would have to be compensated for any missed payments before an equity tranche could be paid.