I read that sequential pay structures redistribute prepayment risk. The Z-tranche however does not reduce or even effect prepayment risk as it is simply the last bond to get back i. and principal. However the z-tranche or subordinate tranche can be apart of the sequential pay-structure… Thanks.
the z-tranche plays an important part. It takes no principal, in addition any interest due to it, is diverted to the other tranches. So it helps reduce the “fear of extension risk” that a higher tranche may have. It helps to reduce the average life of other tranches in the structure. In addition since there is no reinvestment rate risk in this tranche (irrespective of the external interest rate environment, it does not feel any impact ) - it caters to the needs of investors who prefer not to have reinvestment rate risk.
It’s the zero-coupon bond of the structure…but it too can have contraction risk, so that you may not get the guaranteed return as you would on a zero-coupon bond, if prepayments are fast enough.