Reading 56: Mortgage-Backed Sector of the Bond Market Los h~Q

mortgage, support

LOS h: Distinguish among the sequential pay tranche, the accrual tranche, the planned amortization class tranche, and the support tranche in a CMO.

Q1. $400 million of mortgage pass-throughs will be used as collateral for five tranches. The first two tranches are planned amortization tranches?$260 million of bonds of tranche U and $50 million of bonds of tranche V. Tranche U is a planned amortization class (PAC) I tranche and tranche V is a scheduled tranche. The third tranche is a scheduled support tranche—the holders of the $40 million of bonds in tranche W receive principal repayments according to a schedule as long as prepayment speed is between 190 and 240 PSA. The last two tranches are unscheduled support tranches—$25 million of X bonds in a floating-rate support tranche and $25 million of Y bonds in an inverse floating rate support tranche. Which of the following statements regarding the prepayment risk of the bonds is most accurate? The:

A) U bonds have less prepayment risk than the V bonds, which have less prepayment risk than the Y bonds.

B) W bonds have less prepayment risk than the X bonds, which have less prepayment risk than the Y bonds.

C) W bonds have less prepayment risk than the U bonds, which have less prepayment risk than the Y bonds.

Q2. 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.

Q3. 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.

Q4. 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) is retired sequentially.

C) has different credit risk.

Q5. $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 TRUE? 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.