How is a collateralized mortgage obligation (CMO) created? A CMO is created by:
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Creating CMO's distributes the various forms of prepayment risk among different classes of bondholders which allows the CMO to more closely satisfy the asset/liability needs of institutional investors.
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:
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The PAC tranche has significant protection against prepayment risk at the expense of the support or companion tranches.
Which of the following statements regarding CMOs is FALSE? The:
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The early maturing tranches offer relatively greater protection against extension risk, not contraction risk.
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:
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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.
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