Valuation of MBS and ABS

Would higly appreciate if somebody makes for me clear the following statement:

“Tranches trading at a premium(discount) will see gains(losses) when the assumed prepayment rates decreases.” (schweser notes Study session 15. Reading 47, page 291)

if I got correctly from the study session the tranches that should be traded at premium should be senior tranches, which are exposed to prepayment risk less than the supporting tranches wich should be traded at discount because of high prepayment risk in this case. so when the prepatment rates decline, the tranches that bear prepayment risk more should benefit, or experience gains.

A tranche trades at a premium if its coupon is higher than its YTM.

If prepayments decrease, it earns that higher coupon for longer; hence, its value rises.

Conversely for tranches trading at a discount.


My pleasure.