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CFA Level I · CFA Level I Exam · Fixed-Income Securitization

A planned amortization class (PAC) tranche is protected from prepayment risk within a given range of prepayment speeds. The support tranches in the same CMO most likely:

Support tranches bear more prepayment risk than the PAC tranche. They absorb principal cash flows above or below the PAC schedule when prepayments differ from expected, so the PAC cash flows stay stable within its range while the support tranches' timing varies widely.

  1. Abear less prepayment risk than the PAC tranche
  2. Bbear more prepayment risk than the PAC trancheCorrect
  3. Cbear the same prepayment risk as the PAC tranche

Explanation

Support tranches absorb the excess or shortfall in principal when prepayments move away from the PAC schedule. This stabilizes the PAC, which concentrates contraction and extension risk in the support tranches.

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