Question

Suppose there are 4 tranches A, B, C, and a Z-bond class in a sequential-pay agency...

Suppose there are 4 tranches A, B, C, and a Z-bond class in a sequential-pay agency CMO, where tranche A receives principal payments first. Which tranche in this CMO structure is most suitable for an investor that is most concerned about prepayment risk?

Group of answer choices

C

B

Z

A

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Answer #1

Answer-

The correct Option is last choice A tranche.

The tranche  A is the upper tranche and receives the principal payments first and has shorter duration compared to other senior tranches B and C.

The senior tranches B and C have longer maturites and hence have greater prepayment risk compared to tranche A which has a shorter maturity.

Therefore the tranche in this CMO structure is most suitable for an investor that is most concerned about prepayment risk is tranche A.

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