Hey guys, This question is confusing me. There are 3 tranches as follows: PAC Bond Scheduled Bond Support Bond Here’s the question. If there are prepayments, where are those prepayments directed first? Scheduled or Support?
The question doesn’t seem complete, because the PAC bond gets the payments it’s scheduled to receive. Increased/decreased prepayments are absorbed by the support tranche. You need to know whether the prepayments are above/below the PAC collar. The scheduled tranche is used as a method of redistributing credit risk, not prepayment risk.
I don’t remember the term scheduled bond, but at a guess I’d say it is a PAC 2 tranche. Therefore prepayments are directed first to the PAC tranche according to the PAC schedule, then the PAC 2 tranche, according to it schedule, and then whatevers left goes to the support bond. If Scheduled bond is not a PAC 2 tranche, I’d guess that it still falls between the other two types.
are you sure? Regular payments go to the PAC Tranche. If Support has the “capacity” - prepayments go first to that - thus preventing the PAC tranche contraction. If Support tranche is busted - Prepayments would go depending on the capacity to the PAC II Tranche.
This question is killing me and I read over fixed income yesterday from the CFAI book and I’m still confused. A scheduled tranche is a PAC II tranche. BTW the question states that the PAC tranche is in repayment but u don’t have to know anything else about question to answer the question I just gave. Stalla’s answer is “If there are no scheduled PAC bond principal payemnts or if there is excess principal after paying the scheduled PAC bond prinipal repayment, then the scheduled Bond receives prinicipal cash flow to pay it’s scheduled prinicipal repayment. The Support bond receives its prinicipal after both the PAC and the scheduled bond’s requirements have been met” So does this mean that if there are prepayments, it goes to Scheduled bond (PAC 2), however if the Scheduled bond has already covered it’s payment obligations, anything extra would go to the support tranche?
soddy1979 You’re confusing the term subordinate with scheduled. Subordinate tranches are redistributed credit risk.
JP_RL_CFA Wrote: ------------------------------------------------------- > soddy1979 > > You’re confusing the term subordinate with > scheduled. Subordinate tranches are redistributed > credit risk. Thank you.
JP – Can you confirm that what I have written above is the right thing? Terminology is giving me a heartache!!!
The qualifying statement ‘according to the PAC schedule’ is the key part in my description. I’m guessing the PAC bond has some amount of prepayments built into their payment structure, so those would go to the PAC bond, but everything in excess goes to the support tranche first, and then when that is paid off, to the PAC II tranche. Therefore the PAC tranche will receive a perfectly predictable payment as long as the support tranches are there to sustain it. After that it is simply a sequential pay structure.
PAC Schedule corresponds only to the Scheduled Principal and Interest schedule. (is my understanding).
CP That’s correct. PAC and PAC2 (AKA scheduled) have first priority. Any prepayments over the PAC tranche would go to the PAC 2 tranche, if the PAC 2 tranche has already fulfilled it’s obligations (to stay within it’s PAC Collar) that the excess would go to the support tranche. Once the support tranche is paid off, it becomes, as Sbmarti noted, a broken PAC where it turns into a sequential pay structure. In our example the breakdown of the broken PAC would be, PAC gets ALL principle payments once paid off, PAC 2 gets all principle payments
cpk123 Wrote: ------------------------------------------------------- > PAC Schedule corresponds only to the Scheduled > Principal and Interest schedule. > > (is my understanding). Well I suppose no prepayments won’t affect my understanding too much as everything is scheduled, but it’s nice for that to be clarified. Thanks!
I need a cup of coffee.
On that note, I’m going to go get one lol.
support tranches are typically the first loss piece, no question…unless the question stated that within the support trance there were PAC thats the only dilemma. def support tranches