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Basic Question 3 of 8
Select the correct statement(s).
II. The shorter the PAC, the more protection it has against faster prepayments.
III. Whenever actual payments are greater than the initial upper collar, the schedule of principal repayments of a PAC tranche is disrupted.
IV. The effective collar changes every month.
I. The cash flows of a PAC tranche are always stable.
II. The shorter the PAC, the more protection it has against faster prepayments.
III. Whenever actual payments are greater than the initial upper collar, the schedule of principal repayments of a PAC tranche is disrupted.
IV. The effective collar changes every month.
User Contributed Comments 6
| User | Comment |
|---|---|
| danlan2 | Why II is correct? |
| local1407 | i don't understand either with II |
| drew2009 | Well think of it this way since the PAC zone or collar is smaller it covers a lower amount of prepayment speeds in which prepayment cash flows go into the PAC tranche. This leaves a larger area of the support tranches to absorb the excess. Example: Imagine a range 0-10 of prepayment. Compare two differnt PAC collars: Say the PAC collar 1 is 4-7 zone, this leaves 1-3 and 8-10 as zone were support trances absorb excess exentsio risk. Now say PAC collar 2 is only 5-6, this leaves 1-4 and 7-10 as the support absorbtion zones. Thus collar 2 has more protection since the support tranches absorb a large area of risk. |
| quanttrader | IV doesn't need have to be true, what if there is no change in prepayment rate-- the collar will remain the same -no? |
| czar | thanks Drew2009 |
| ascruggs92 | quanttrader, I thought the same thing, but now after re-reading the explanation, it might make sense that it changes every month. Because it is a range as opposed to a single value, it may be the case that the collar makes some sort of adjustment based on how close to the bottom or the top of the range the payment was, even if payments are always within the boundaries. |
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Learning Outcome Statements
describe types and characteristics of residential mortgage-backed securities, including mortgage pass-through securities and collateralized mortgage obligations, and explain the cash flows and risks for each type
CFA® 2024 Level I Curriculum, Volume 4, Module 19.