Question

For agency stripped CMOs, which of the following allow the investor to receive majority of the...

For agency stripped CMOs, which of the following allow the investor to receive majority of the cash flow earlier?

Both receive majority of the cash flow at the same time

Interest tranche

Principal tranche

Cannot be determined

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Answer #1

Answer: Interest Tranche

The interest amount on the CMO has a diminishing cashflow as time goes on due to the fact that the principal gets repaid overtime resulting in the base used to calculated interest to be lower than that of the previous period. On the contrary the principal tranche would receive majority of their cashflow towards the end of the loan period as installment payment values are constant and interest portion of the installment sees a decline over time so the balance comes from the prinipal portion.

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