Question

Question 6 Mark all the true statements about CMOs:

A Tranche stands for \slice" in french

B CMO can have several classes (tranches) of securities backed by the same pool of mort-gages

C In a sequential pay CMO, the tranche that gets paid o rst is protected against con-traction risk

D In a sequential pay CMO, all tranches get their interest payments except for Z-bonds

E In a sequential pay CMO, the tranche that gets paid last assumes the least default risk2

Answer 1

a. TRUE.

b. TRUE

c. FALSE. No the tranche that gets paid first is protected against extension risk. Extension risk occurs when they do the opposite they defer loan payments, increasing the length of the loan. Investors with shorter investment horizons, such as commercial banks, could purchase bonds from senior tranches in order to protect their investments from extension risk.

d. TRUE.  Z bond, does not receive current interest. Instead, the Z bond's interest is used to pay down the principal on the other tranches, increasing their speed and reducing their average life.

e. FALSE. The tranche gets paid the last has the most risk of default as it has the most junior payment order.