PAC/Support/Accrual

CFA Level II
#1

I still get them wrong sometimes so apparently my logic isn’t waterproof on these. Could someone help me out and explain that the benefits/downsides are for each of these tranches?

#2

PAC - relatively small prepayment risk (smaller interest) Support - high interest (high prepayment risk) Accrual - similar to support

#3

maratikus what are the differences between accrual and support?

#4

In the accrual, the interest payments aren’t paid to the accrual tranche and are instead paid to senior tranches.

#5

PAC - insulated from BOTH contraction and extension risk

#6
  1. Accrual bonds generally have much longer lives (15+ years) than support tranches. 2) Accrual bonds accrue interest that is taxable in the US without cash payments casuing the usual OID tax problems 3) Support bonds provide prepayment protection to only a few tranches while the accrual tranche is the last layer of support for everything
#7

So the accrual is riskier than the support tranche?

#8

thanks guys

#9

joeyd always giving the best answers…thanks man

#10

does Z-bond increase PAC tranches’ prepayment risk?

#11

naivejoe Wrote: ------------------------------------------------------- > does Z-bond increase PAC tranches’ prepayment > risk? the debate rages on… http://www.analystforum.com/phorums/read.php?12,749979,761496#msg-761496 we’ve been going round and round on this same question? The Secret Sauce says Z reduces prepayment risk of other tranches CFAI question in 2006 Exam indicates Z has “no effect” on preayment risk of other tranches. Fundamental to this debate is whether extension risk is also considered a type of prepayment risk.

#12

No Z-bonds are there to take on risk. The prepayment risk of th PAC tranches has lots more to do with other PAC/TAC tranches and support tranches than it has to do with the Z-tranche, however.

#13

I agree. The prepayment risk for PAC tranches is concerned with other underlying factors. The inclusion of the Z-tranche shortens the average life of the PAC tranches by speeding up the principle payments, but these are scheduled principle payments. Prepayment risk is not reduced for any tranche, but reinvestment risk is increased for the PAC tranches as they receive principle faster than they otherwise would have.

#14

from the mock exam…if I were afraid of interest rates rising that means I am afraid of extension risk right? So in that case I would buy a support bond?

#15

LongOnCFA Wrote: ------------------------------------------------------- > from the mock exam…if I were afraid of interest > rates rising that means I am afraid of extension > risk right? Yes >So in that case I would buy a support bond? No, you would prefer the first tranche in sequential or PAC.

#16

no because the planned prepayment rates from the PAC will be supported by the support bond. So extension risk for the support tranche is bigger than for the PAC.

#17

LongOnCFA Wrote: ------------------------------------------------------- > from the mock exam…if I were afraid of interest > rates rising that means I am afraid of extension > risk right? So in that case I would buy a support > bond? If you think interest rates are rising, you probably shouldn’t be buying any normal bond.

#18

dudes - isnt an accrual tranche basically a support tranche for a sequential pay as opposed to pac? thats kinda how i viewed it