Quick FI Quiz to warm everyone up

Which of the following risk(s) to CMOs redistribute? 1. Credit 2. Reinvestment 3. Interest 4. Default 5. Prepayment

Prepayment, and I’d also argue reinvestment. Contraction risk, as a result of falling rates, means I must reinvest that money at the new lower rates.

Def prepayment, can be credit as well depending on the trance structure


  1. Credit 2. Reinvestment 5. Prepayment

can someone explain the thinking behind the credit risk? I’m guessing a sequential-pay structure (the tranches that get paid later would have more credit risk than the senior tranche that gets paid off sooner)? Is there any additional structures, etc. that impact credit risk redistribution?

I say: 1. prepayment 2. Reinvestment 3. Interest CMO’s would not be subject to credit or default risk, they are agency backed mortgages.

correct answer is prepayment and interest

plz explain how reinvestment is not an answer?

reinvestment is definitely an answer, especially if interest rate(price) risk is an answer, once interest rates are low, then refinancing will occur, with the lender receiving the principal at low interest rates they have to now reinvest the principalat those low rates, so reinvestment risk must be possible

Jeffsick - My mistake. You’re correct. The accrual tranche is for those who are concerned with reinvestment risk.

so the ans. is: 1. prepayment 2. reinvestment 3. interest Correct?

How is credit risk not redistributed?