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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.
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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