CFA Level I · CFA Level I Exam · Mortgage-Backed Security (MBS) Instrument and Market Features
A planned amortization class (PAC) tranche in a CMO has a stable cash flow schedule as long as prepayment speeds stay within an initial band. The tranche that most likely absorbs the prepayment variability that the PAC avoids is the:
Support tranches, also called companion tranches, absorb prepayment variability so the PAC tranche can keep its planned schedule within the band. They receive extra principal when prepayments are fast and less when slow, so they carry greater contraction and extension risk.
- Asupport tranche.Correct
- BZ-tranche (accrual bond).
- CPAC tranche with the longest maturity.
Explanation
Support (companion) tranches take on excess principal when prepayments are fast and give up principal when they are slow, protecting the PAC. A Z-tranche accrues interest and is a sequential feature, not the PAC protector. Another PAC tranche is itself protected.
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