Question

The following is a Sequential-Pay CMO:

Tranche	Par Amount	Coupon Rate (%)
A	$194,500,000	7.5
B	36,000,000	7.5
C	96,500,000	7.5
D	73,000,000	7.5
Total	$400,000,000

The principal payment is to be received first by Tranche A, then B, then C, then D.

     (a) (1 point) Before Tranche A is paid off, what is the total cash flow to the Tranche B investors per month?

     (b) (1 point) Which tranche is most sensitive to the declining interest rate? Why?

Answer 1

a) Tranche B investors will be getting only interest coupon payments and no principle repayments as Tranche A is not completely paid off, therefore total per month cash flows for Tranche B investor are:

Interest coupon payments = Principle * Interest rate( per month )

Annual coupon rate on Tranche B = 7.5%

Per Month Coupon rate = 7.5%/12

Principle = 36,000,000 $

Interest coupon cash flows per month = 36000000 * 7.5%/12 = 225,000 $

b) Tranche D is most sensitive to the declining interest rate. Tranche D has the last priority amongst the four tranches for principle repayment, hence tranche D investor will be the last one's to get their principle repayments back and in a declining interest rate scenario they will have to reinvest their principles (which is a larger cashflow than coupon repayment) at prevailing lower interest rates therefore they are the most sensitive.