CFA CFA Level 1 time tranching continued

time tranching continued

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      How would you do the sequential losses for this example from the CFA institute? Would it be the same? A first, then B, then C?

      Exhibit 3

      CMO-01: Sequential-Pay CMO Structure with Four Tranches

      Tranche Par Amt coupon

      A 389 5.5%

      B 72 5.5

      C 193 5.5

      D 146 5.5

      Payment rules: For payment of monthly coupon interest: Disburse monthly coupon interest to each tranche on the basis of the amount of principal outstanding for each tranche at the beginning of the month. For disbursement of principal payments: Disburse principal payments to Tranche A until it is completely paid off. After Tranche A is completely paid off, disburse principal payments to Tranche B until it is completely paid off. After Tranche B is completely paid off, disburse principal payments to Tranche C until it is completely paid off. After Tranche C is completely paid off, disburse principal payments to Tranche D until it is completely paid off.

      Remember that a CMO is created by redistributing the cash flows—interest payments and principal repayments—to the various tranches on the basis of a set of payment rules. The payment rules at the bottom of Exhibit 3 describe how the cash flows from the mortgage pass-through security are to be distributed to the four tranches. CMO-01 has separate rules for the interest payment and the principal repayment, the latter being the sum of the scheduled principal repayment and the prepayments.

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      So as per your other question, credit tranches and prepayment tranches doesn’t necessarily have to be the same. Tranche A principal is paid first, but it could just be that Tranche A investors want a shorter repayment timeline.

      In the absence of any extra information I would say credit tranches follows prepayment tranches (i.e. A,B,C,D) given the coupon rate is the same across the board.

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