A sequential-pay collateralized mortgage obligation (CMO) with ain accrual tranche lowers the prepayment risk and shortens the average life of the sequential-pay tranches relative to a sequential-pay CMO without an accrual tranche. Is the above conclusion correct? A) Yes, duh! B) No, because the an accrual tranche increases prepayment risk C) No, because an accrual tranche has no effect on prepayment risk
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C accrual tranche affects contraction and extension risks but the prepayment risk is the same. Support tranche is the one that affect the prepayment risk.
sequential pay means each tranche gets paid in order, with the accrual tranche (z-tranche) at the end. I would go with answer C
right, prepayment risk can’t be affected by accrual trance. C is the right i’d say.
yup, C is the correct answer. I’m thrown off now. 2008 secret sauce says that the accrual bonds absorb most of the prepayment risk in a sequential-pay structure. Second point, what is the difference between support tranche and the accrual tranche. I know support tranche has higher contraction and extension risk than the PAC, thus the support tranche has higher prepayment risk. But doesn’t the Z-tranche have higher extension risk since it is the last to be paid?
yea accrual has higher extension risk. Support trache act as a buffer with both prepayments and “underpayments”. Schweser book 5 pages 126-127 clears it up.
Is there an accrual tranche in a PAC structure? I normally think of support tranches with a PAC structure and an accrual tranche with a sequential pay structure. As I understand it, the support tranche in a PAC structure absorbs the prepayment (contraction or extinction) risk, allowing most the relative certainty of the PAC holders.
I think it’s a trick wording question. The accrual tranche or Z-tranche does not lower pre-payment risk. The only thing that lowers pre-payment risk is higher rates. What the Z-tranche does is it mittigates the risk by absorbing both contraction and expansion risk. In hindsight it seems clear but definitely would have chosen A without thinking about it.
you guys are missing the point here… in a sequential pay CMO if tranche A has 50 million of principle outstanding, it receives all principle payments (prepayments or otherwise) until the 50 million is paid off. After that, the principle payments go to B, and so on. The other tranches just receive interest payments until the tranches above them are paid off.
these are the threads where your overall study time is best enhanced by avoiding
there are a lot of them now… i think i’m just going to stop responding… time to review alts
SkipE99 Wrote: ------------------------------------------------------- > these are the threads where your overall study > time is best enhanced by avoiding unfortunately this was taken directly from CFAI EOD. if it was anything from shitser or stalla it would not have been promoted to the board. I hope it doesn’t show up on the exam.
ok I figured it out. The accrual tranche doesn’t do anything for prepayment risk because it is simply the last tranche in a CMO structure. it offers no protections. Support tranches affect prepayment risk because they offer protection to the PAC tranches. Its as simple as that. Hope that helps everyone.
floaters and inverse floaters act as support tranches correct ?
No