Skip to content

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

A sequential-pay CMO is backed by a mortgage pool and has Tranche A, Tranche B and Tranche C, paid in that order. All principal payments, scheduled and prepaid, go first to Tranche A until it is retired. If prepayment speeds rise unexpectedly, what is the most likely effect on Tranche A?

Tranche A's average life shortens. In a sequential-pay CMO, all principal, including prepayments, goes to the first tranche until it is retired, so faster prepayments retire it sooner. Slower prepayments would extend it instead.

  1. AIts average life shortensCorrect
  2. BIts average life lengthens
  3. CIts coupon rate is reset higher
  4. DIts principal is written down

Explanation

In a sequential-pay structure the first tranche receives all principal until it is retired. Faster prepayments therefore send more principal to Tranche A sooner and shorten its average life. Extension risk is the concern for lengthening, which arises when prepayments slow.

Did you get it right without looking?

One question tells you little. A timed set on Mortgages and Mortgage-Backed Securities shows your real accuracy, how long you take and where you lose marks.

Practise Mortgages and Mortgage-Backed SecuritiesFree diagnostic mock

More Mortgages and Mortgage-Backed Securities questions