PAC Tranches average, examples, 300, conversion, receive

dirk01

A little confused how these operate. Assume the example in the book PSA 90-300.

If the actual prepayment is inside the collar, say PSA 200, how much does the PAC participant receive -- the minimum amount (90 or 300), or 200?

Also, are we supposed to be able to convert PSA to average maturity? I see the conversion being shown in various examples, but I haven't located a formula for doing so.

I have other questions, but I'm so confused right now that I can't formulate them.

- Robert

ryanlb

Let me rephrase the above post (my edit time expired).

If the actual prepayment is inside the collar, say PSA 200, the PAC I participant receives the minimum amount (PSA 90 or 300 as the case may be). In that case, the support tranche absorbs the contraction. Right?

If the prepayment is outside the collar, the PAC tranche absorbs the contraction or the extension, right?

What would be an example where the support tranche absorbs the extension?

- Robert

Otabek

The companion tranche absorbs the contraction or the extension risk, the payments to the PAC tranche are limited by the prepay collar.

Swanand

Regarding my question about extension risk:

If the PAC tranche is already paid at the minimum point of the collar (say PSA 90), how is extension risk mitigated by Support? PSA would have to drop below 90, and then you'd be outside the collar.

Also, are we supposed to be able to convert PSA to average maturity? I see the conversion being shown in various examples, but I haven't located a formula for doing so.

- Robert

neil1234

if the actual prepayments are below the collar, then the principal paid to the support tranche is directed to the PAC. this means that more of support bond is outstanding (or the holders of the support bond have an extension risk)

I doubt they will ask us to compute the WAL for a PAC.. you will need to compute the principal paid down every month using the 2 different psa's and pick the one with the lower payment.

maryli

The PAC could receive an amount within the collar band, not necessarily at the bare minimum. If the PSA is 200, then the PSA is 200. Not arbitrarily 90 (the lower end of the band). If it faces extension risk, then the junior tranches eat the loss first and senior gets the bare minimum of the collar.

Maybe I'm not understanding your question, because it seems pretty straight forward to me.

sameeragarwal

At the risk of sounding totally lost, let's assume the collar is PSA 90-300, but the actual payments are running more like 200 (somewhere in the middle of the collar), and we're in the early days.

What does the PAC tranche get -- 90?

- Robert

onelife1

Here's what is tripping me up.

The purpose of the collar it to mitigate prepayment risk -- contractions and extensions. Conceptually, this works so long as actual prepayments fall within the effective collar.

What confuses me is the fact that the PAC normally receives the minimum side of the collar band, not some other point in the band. To my understanding, this protects contraction risk only (prepayments inside the collar will always exceed the minimum). Extension risk is only mitigated when prepayments fall below the lower bound, and by definition you're outside the collar.

So how does this structure reduce extension risk for PAC holders?

- Robert

flyinggirl

PAC tranche gets 200

profil

if PSA is 305, support tranche absorbs 5.
if PSA is 85, Support tranche feed 5 to pac.