shift interest scheme

according cfa level 2 text, if applying the shift interest scheme, the senior tranche will get more prepayment risk, I have difficulty in understanding this, can some one elaborate. thanks also why the text mentions that shift interest scheme is credit enhanced solution, it should be opposite. credit enhanced solution should protect senior tranche more, right?

As prepayments increase, subordinate tranches get eroded, correct? Now, understand that there are 2 roles these subordinate tranches play. They protect senior tranches from Credit Risk and from Prepayment Risk. So, when due to increased prepayments, subordinated tranches are getting eroded, we will want to allocate some prepayments to senior tranches so as to preserve subordinate tranches in order for them to continue to protect senior tranches against Credit Risk.

as above. idea is to protect against defaults, thus shifting schemes allows priority payments to be made to senior tranches, which, whilst lowering their credit risks, increase contraction risks.

thanks. but you type wrongly, it should be "we will want to allocate some prepayments from senior tranches to subordinate tranche so as to preserve subordinate tranches " thus shift interest (which is originally to senior tranche) from senior, now to subordinate. but why not shift some principal from senior to subordinate? can i say shift interest scheme is one kind of internal credit enhance?

if you shift principal what happened to the tranche investors? Would they allow that? What are they there for? Are they dummies waiting for the house to be sold from under them? They are waiting for the interest and the principal they have invested in to be recouped, right? It is not a credit enhancement. Shifting interest is kind of a reverse protection from senior to subordinate. Kind of Senior saying - you have protected me for so long. Now its my turn to give you some relief so you can continue to protect me.

> thanks. but you type wrongly, it should be "we will want to allocate some prepayments from senior tranches to subordinate tranche so as to preserve subordinate tranches " No i didnt, infact i dont agree with what you say in these quotes. Prepayments come from the underlying pool and not from Senior or Subordinate tranches as you are indicating. Once they are there, they need to be allocated to either senior or subordinate tranche depending on predefined rules in the prospectus. > but why not shift some principal from senior to subordinate? How can you shift principals around. If you lend money, would it be okay to you if some of your principal is paid to me? > can i say shift interest scheme is one kind of internal credit enhance? Yes, this is quite correct.

ok, thanks rus1bus

This only applies to asset backed securities correct?

First of all - yes, this does only apply to the asset backed Sector. second this is how I rationalize shifting interest. the subs in this structure w/out a shifting interest structure would absorb both prepayments and credit losses. if prepayments are sufficiently high they will erode the entire subclasses away leaving the seniors succeptable to both credit and further prepayment losses. w/ a shifting int. structure a portion of the prepayments are allocated to the senior classes, leaving more principle available to absorb credit losses in the subs. credit losses are caused by defaults, prepayment losses are caused by early or late payments of principle. so I ask you wich would you rather have, a late payment or no payment at all? This is why they create the shifting int. strucure.

so you mean senior tranche will have immediate exposure to prepayment risk after shift interst scheme is implemented? prepayment losses are caused by early payments of both principle and interest. thus your opinion is wrong, late payment is not prepay risk. shift interest scheme means shift interest received from sr to sub tranche. not the prepayment, you are not correct