CFA Level I · CFA Level I Exam · Mortgage-Backed Security (MBS) Instrument and Market Features
In a CMO structure, a Z-tranche (accrual tranche) is best described as a tranche that:
A Z-tranche is an accrual bond whose interest is added to its principal balance instead of being paid in cash until earlier tranches are retired. The diverted interest speeds principal payments to earlier tranches, shortening their average lives and reducing their extension risk.
- Areceives interest and principal first.
- Bpays a floating rate tied to a reference rate.
- Caccrues interest added to its balance until prior tranches are retired.Correct
Explanation
A Z-tranche receives no current cash interest; interest accrues to principal, and cash payments begin after earlier tranches are retired. The accrued interest helps pay down earlier tranches faster, shortening their average lives. It is not paid first and is not defined by a floating rate.
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