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FRM Part I · FRM Exam Part I · Mortgages and Mortgage-Backed Securities

A sequential-pay CMO has a USD 300 million collateral pool, split into Tranche A (USD 100 million), Tranche B (USD 120 million) and Tranche C (USD 80 million). In month 1 the pool generates USD 6 million of scheduled principal and USD 9 million of prepayments, with no losses. Which statement is correct about the principal distribution in month 1?

Tranche A receives the full USD 15 million. Scheduled principal of 6 plus prepayments of 9 total 15, and a sequential-pay CMO pays all principal to the first tranche until its USD 100 million balance is retired.

  1. ATranche A receives USD 15 millionCorrect
  2. BTranche A receives USD 5 million and Tranche B USD 10 million
  3. CTranches A, B and C share USD 15 million pro rata to balance
  4. DTranche A receives USD 9 million and Tranche B USD 6 million

Explanation

Total principal is 6 + 9 = USD 15 million. In a sequential structure all of it goes to Tranche A because A's balance of USD 100 million exceeds 15 million. Pro rata sharing would be a different structure, and splitting scheduled versus prepaid principal is not how sequential tranches work.

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