# Fixed Income Qbank

\$400 million of mortgage pass-throughs will be used as collateral for five tranches. The first two tranches are planned amortization tranches−\$260 million of bonds of tranche U and \$50 million of bonds of tranche V. Tranche U is a planned amortization class (PAC) I tranche and tranche V is a scheduled tranche. The third tranche is a scheduled support tranche—the holders of the \$40 million of bonds in tranche W receive principal repayments according to a schedule as long as prepayment speed is between 190 and 240 PSA. The last two tranches are unscheduled support tranches—\$25 million of X bonds in a floating-rate support tranche and \$25 million of Y bonds in an inverse floating rate support tranche. Which of the following statements regarding the prepayment risk of the bonds is most accurate? The: A) U bonds have less prepayment risk than the V bonds, which have less prepayment risk than the Y bonds. B) W bonds have less prepayment risk than the U bonds, which have less prepayment risk than the Y bonds. C) U bonds have less prepayment risk than the Y bonds, which have less prepayment risk than the X bonds. D) W bonds have less prepayment risk than the X bonds, which have less prepayment risk than the Y bonds.

A?

prepayment risk in ascending order U, V, W, X, Y Hence A should be the answer

U = 260m PAC-I V = 50m PAC (scheduled tranch) W = 40m Scheduled (Tranch Collar - speed = 190PSA to 240PSA) X = 25m Suport Tranch (uncheduled) Y = 25m Suport Tranch (uncheduled) Since W is bounded by 190PSA min and 240PSA max, so W’s boundaries are already decided as far as prepayment speed is concerned. Any overshooting of prepayments in excess of those boundries are absorbed by Y and when it’s capacity is over, they are soaked-up by X, if X’s capacity is reached too, then they start flowing into V and then into U. So, I feel the order is W < U < V < X < Y … W having the least prepayment risk. so A or D …both sound correct

Could you guys clarify why there is a ranking between X and Y? I was thinking that they are both support tranches and would be allocated any prepayments on a pro-rata basis. The only differences between the two seems to be the interest payment scheme (floater vs inverse floater).

I believe the answer is A but that seems too obvious so it is probably something else.

i’d also go w/ A.

A should be the answer because X and Y have equal prepayment risk.

A was the correct answer. Just to make sure I understand this, D is wrong because X and Y have the same prepayment risk? Official Answer: Even though U and V are sequential pay tranches, they are also PACs. Once the PSA rate is exceeded by the tranche collars the support tranches absorb all the prepayment risk first and then the prepayment risk is absorbed by the tranches in reverse order with the lower unscheduled tranches absorbing more prepayment risk before the higher scheduled tranches. Therefore tranche V would have more prepayment risk than tranche U. Support tranches X and Y have the greatest prepayment risk because they are unscheduled and lowest in the order of tranches. Tranche W will have less prepayment risk than X and Y followed by V and lastly U since once again prepayment risk for PACs is highest at the lower tranches and lowest at the upper tranches.

I asked the same questions a few months ago. Here is a link to the discussion. http://www.analystforum.com/phorums/read.php?12,628146,628772#msg-628772

Thanks for that mwvt9, that was quite helpful.

wanderingcfa Wrote: ------------------------------------------------------- > A was the correct answer. > > Just to make sure I understand this, D is wrong > because X and Y have the same prepayment risk? The only difference between X and Y is that one is a floater and the other one is an inverse floater. Their prepayment risk is the same (the supporting tranche was split into two)

maratikus Wrote: ------------------------------------------------------- > wanderingcfa Wrote: > -------------------------------------------------- > ----- > > A was the correct answer. > > > > Just to make sure I understand this, D is wrong > > because X and Y have the same prepayment risk? > > The only difference between X and Y is that one is > a floater and the other one is an inverse floater. > Their prepayment risk is the same (the supporting > tranche was split into two) ok, i knew this asshat Schweser question would be discussed on analystforum. according to page 352 of CFAI text, the last two supporting tranches are considered ONE tranch. therefore, X and Y have the SAME prepayment risk. X and Y with their floating and inverse floating tranches are combined to create a floating rate tranche because the collateral pays fixed rate and the servicer pays out a floating rate. problem solveddddddd