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- 2014-8-7
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Robert,
This had me confused for a while too, but I think this will make sense.
Here is an example of support bonds providing protection against extension risk.
Let's say in Month 5, the prepayment falls short of schedule (increased extension risk).
Note that the support bonds will not receive any principal payments while PAC receives at least some. Then in Month 6, there is an inflow of prepayment and the entire cash flow will go to PAC until amortization schedule is back on track.
Ultimately, PAC receives more prepayment than a bond with sequential-pay structure would under this lower-than-expected prepayment schedule. |
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