cyber21

Which of the following best describes how planned amortization class (PAC) bonds are protected against prepayment risk to create products that provide better asset and liability matching for institutional investors? PAC bonds:

A) have a fixed principal repayment schedule that must be satisfied as long as the support tranches exist.

B) accrue the interest for one tranche and redistribute it to the support tranches.

C) have several different companion tranches to which repayments are directed sequentially.

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The PAC tranche has significant protection against prepayment risk at the expense of the support or companion tranches.

cyber21

Which of the following statements regarding CMOs is least accurate? The:

A) early maturing tranches offer relatively greater protection against contraction risk.

B) early maturing tranches offer relatively greater protection against extension risk.

C) longer-term tranches offer relatively greater protection against contraction risk.

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The early maturing tranches offer relatively greater protection against extension risk, not contraction risk.

cyber21

Which of the following best describes how accrual bonds distribute prepayment risk among tranches to create products that provide better asset and liability matching for institutional investors? Accrual bonds:

A) accrue the interest for one tranche and redistribute it to the other tranches.

B) have a fixed principal repayment schedule that must be satisfied as long as the support tranches exist.

C) have several different tranches to which accrued interest is directed sequentially.

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For many sequential-pay CMO structures, the last tranche to be paid principal also does not receive current interest until the other tranches have been paid off. This tranche is called the Z-tranche or accrual tranche, and the securities that represent a claim against its cash flows are called Z-bonds or accrual bonds. The interest that would ordinarily be paid to the accrual tranche is applied against the outstanding principal of the other tranches, in sequence. The diverted interest from the accrual tranche accrues. That is, it is added to the outstanding principal balance of the Z-tranche.

cyber21

Two structures of collateralized mortgage obligations (CMO) are being considered. In the first structure, $300 million of pass-throughs will be used as collateral for two sequential-pay tranches: $225 million of bonds of tranche U and $75 million of bonds of tranche V. The principal for tranche U must be completely paid off before any payments are made to tranche V. In the second structure, the $300 million of pass-throughs will be used as collateral for $225 million of X bonds in a planned amortization tranche and $75 million of Y bonds in a support tranche. Which of the following is least accurate? The:

A) X bonds have less contraction risk than the Y bonds.

B) U bonds have less contraction risk than the V bonds.

C) U bonds have less extension risk than the V bonds.

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The U bonds have less extension risk, but they provide protection for the V bonds against contraction.

cyber21

Which of the following is most accurate for a companion tranche with a schedule of principal repayments? Such a companion tranche:

A) has greater protection against prepayment risk than a support tranche without a schedule of principal payments.

B) has no prepayment risk.

C) provides less protection against prepayment risk than a support tranche without a schedule of principal payments.

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PAC II tranches are companion tranches having PAC prepayment schedules. Like regular PAC tranches, these scheduled support tranches receive a degree of prepayment risk protection at the expense of increased prepayment risk to other support tranches.

cyber21

Which of the following is referred to as a sequential-pay CMO? A sequential-pay CMO is structured so that each class of bond:

A) receives prepayments on a sequential pro-rata basis.

B) has different credit risk.

C) is retired sequentially.

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When there are prepayments, the principal in the first bond class (tranche) is reduced until it is fully retired, then the principal of the next bond class is retired, and so on.

cyber21

$200 million of mortgage pass-throughs will be used as collateral for three tranches. The first two tranches are planned amortization class tranches: $110 million of bonds of tranche U and $50 million of bonds of tranche V. The third tranche consists of the holders of the $40 million of bonds in tranche W, which is a support tranche. Which of the following statements regarding the contraction risk and extension risk of the U bonds versus the V bonds is most accurate? The U bonds:

A) have less contraction risk and less extension risk than the V bonds.

B) have less extension risk but not less contraction risk than the V bonds.

C) have less contraction risk but not less extension risk than the V bonds.

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The planned amortization portion of the tranches allows for the lower support tranches to absorb the prepayments first with the upper tranches having the least amount of prepayment risk with tranche V having more prepayment risk than tranche U because U is more senior than V. Because U has the least amount of prepayment risk it also has the least amount of contraction risk once again because all the lower subordinate tranches and support tranches absorb the prepayments first.

cyber21

Which of the following explains why the companion tranches have the greatest prepayment risk in a CMO structure? The companion tranches:

A) are more interest rate sensitive and therefore prepayment risk is higher.

B) have to support any principal payments in excess of the scheduled principal payments.

C) consist of underlying mortgages for which prepayment is allowed, as opposed to the PAC tranches.

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There is an inverse relationship between the prepayment risk of PAC tranches and the prepayment risk associated with the support tranches. In other words, the certainty of PAC bond cash flow comes at the expense of increased risk to the support tranches.

cyber21

Which of the following is least accurate regarding planned amortization class (PAC) versus support tranches?

A) The prepayment risk protection provided by the support tranches causes the average life to extend and contract.

B) The PAC tranches have the greatest prepayment risk in the collateralized mortgage obligation (CMO) structure.

C) There is an inverse relationship between the prepayment risk of the PAC tranches and the prepayment risk associated with the support tranches.

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The support tranches have the greatest prepayment risk in the CMO structure, not the PAC tranches.

cyber21

How is the price of a principal-only mortgage strip affected by declining mortgage rates in the market? The price of the principal-only strip:

A) increases.

B) decreases.

C) is unaffected.

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When mortgage rates decline, prepayments are expected to increase. Therefore, the principal-only strip investor gets payments sooner increasing the value of the PO.