Reading 55, MBS, Q21 (Pg 421) - CFAI - I'm wondering security, average, manager, shorter, better

pacmandefense

Question: from the manager of saving&loan association portfolio, which MBS is better:
1. Passthrough security with a WAM of 310 months or
2. PAC tranche CMO with average life = 2years
Answer from book: choice 2 with shorter average life, due to less extension risk.
Why only extension risk?

laurab

PAC Tranche gets scheduled payments only. Any additional payments (prepayments beyond the scheduled principal) - would go to the support tranche.
So it will have less extension risk. And given the structure and the size of support available, it is unlikely to contract as well.

d2rockstar

My thought process.
The question asked which one would probably be better from an ASSET/LIABILITY point of view.
They both have prepayment risk but option ii has lower extension risk.