prepayment risk question, reading, income, reduce

HuskyGrad2010

Hi all,

How would you define prepayment risk ?
I thought it was contraction risk + extension risk.

On reading 59, question 27 (page 528, book alternative and fixed income) they state that an accrual tranche has no effect on prepayment risk.
Since accrual tranche will not be pay back until the other tranche are paid back I thought it will reduce extension risk -? so it reduces prepayment risk. Where am I wrong ?

Swanand

An accrual tranche is like a zero-coupon bond in that it accrues interest (adds it to principal). So, if there was prepayment, this tranch does not get hit at all because it only gets interest and nothing else. In that sense, it does not have any impact on prepayment risk....that's from the top of my head as I'm away from books.

benbenxiong

I agree with you.
So extension risk is not included in prepayment risk ?

yodacaia

Loup_Fenrir Wrote:
-------------------------------------------------------
> I agree with you.
> So extension risk is not included in prepayment
> risk ?


Yes it is, but your other comment about accrual tranche is the more interesting point.

kkn006

Anyone can help ?

ningning1984

This is mentioned in the errata. Although, the answer didn't change, the explanation did.

The key word is "indeterminable".

maryli

Oh thank you Iginla2010!