can anyone explain… i think it is a tranche that gets interest only… b/c coupon on collateral > coupon for the tranche… but i dont understand it
a principal only trach is a tranch that has only prinicipal attached to it. No interest. There is an interest only tranch as well. if that is what you are asking?
you split the interest part and principal part. That means you do not get interest for this one, just the principal. The interest is paid to the interest tranche. What you may see on the exam is the effect of contraction and extension risk on these two. Contraction: Good for Principal (get my money earlier) and Bad for interest (fewer payments) Extension works the other way around. Does this help and is it what you were looking for?
i dont think so… in my notes i have “notional principal only tranche” something about it getting the excess interest… i have bad notes on this, thats why i asked… maybe i was taking notes in my sleep again…dammmmmmmmm so no one ever heard of this? did i make this up… omg…
doesn’t ring a bell.
mcpass can i ask you please re the prices? when the prepayments increase the price of a principal only tranche increase right while the price of an interest only trach will decrease… thanks
yes
PO negatively relate to mortage rate, when mortage rate is low, prepayment rate is high and investor receive payment early, thus high yield. IO positively relate to mortage rate, when mortage rate is low, prepayment rate is high and principal get lower fast, and interest payment gets lower, thus low yield,
PO – receive only principal. Sold at a discount to par. Go up when prepayments rise and yield goes through the roof. IO – receives only interest. Start out with big cash flows and gets smaller. Shorter effective lives than POs. Want prepayments to be slow. Ie. Want extension risk. Both PO and IO have greater price volatility than the pass-through.
The CFA textbook (FI- page 188) described a Structured Interest Only tranche that had a notional principal (and this is nothing to do with the IO/PO strips described above). This sounds something like your note. Essentially, the coupon rates on other tranches (eg: sequential pay) are set below the rate provided by the collateral in order to generate excess interest. The Structured IO tranche pays off this excess interest to the tranche holder, and a notional principal is calculated for this tranche. Eg: If you pay 1% less interest on one normal tranche with par value 100k the notional principal for the structured IO tranche paying 7% is = (1% * 100k)/7% = 14.29k If you have 5 such tranches funding the structured IO tranche the notional principal will now be approximately 14.29*5=71.45