Skip to content

CFA Level I · CFA Level I Exam · Mortgage-Backed Security (MBS) Instrument and Market Features

Compared with the collateral pool, the early tranches of a sequential-pay CMO most likely have:

Early tranches in a sequential-pay CMO have more contraction risk and less extension risk than the collateral. They absorb all principal first, so faster prepayments shorten them sharply, while slower prepayments still leave them paid ahead of later tranches, protecting against extension.

  1. Aless contraction risk and more extension risk.
  2. Bmore contraction risk and less extension risk.Correct
  3. Cthe same contraction and extension risk as the collateral.

Explanation

Early tranches receive all principal first, so when prepayments rise they are retired quickly, which is contraction risk. When rates rise and prepayments slow, they are still paid ahead of later tranches, so their extension risk is reduced. Later tranches bear the opposite profile.

Did you get it right without looking?

One question tells you little. A timed set on Mortgage-Backed Security (MBS) Instrument and Market Features shows your real accuracy, how long you take and where you lose marks.

Practise Mortgage-Backed Security (MBS) Instrument and Market FeaturesFree diagnostic mock

More Mortgage-Backed Security (MBS) Instrument and Market Features questions