is it possible for the senior tranche to take on so much of the prepayment risk that it in fact has more prepayment risk than the support tranche does? Or are we to assume that in a shifting interest mechanism, the senior tranche takes on some prepayment risk for the sake of less credit risk, but never enough so as to say it actually has higher prepayment risk than the support tranche?
From what i understand from the book is that…the senior tranche will take on a certain level of prepay risk in the earlier years so that it can have less credit risk. This amount can be adjusted in the prospectus if the amount of prepay risk is too much as to affect the credit risk of the senior tranche. sorry if this confuses u more…
Basic question: How can taking more contraction(prepayment) risk by senior tranch reduce the credit risk??
They get their principal back sooner? It won’t be exposed to the market at that point.
Can I interprete it as value at risk for senior tranch goes down because of absorbing prepayment?