- CFA Exams
- CFA Level I Exam
- Topic 6. Fixed Income
- Learning Module 19. Mortgage-Backed Security (MBS) Instrument and Market Features
- Subject 4. Collateralized Mortgage Obligations
CFA Practice Question
The presence of a shifting interest mechanism ______ for the senior tranche.
II. increases contraction risk
III. reduces credit risk
IV. reduces contraction risk
I. increases credit risk
II. increases contraction risk
III. reduces credit risk
IV. reduces contraction risk
Correct Answer: II and III
The shifting interest mechanism is a trade-off between credit risk and contraction risk for the senior tranche because it receives a larger share of any prepayment.
User Contributed Comments 2
| User | Comment |
|---|---|
| wink26 | Allocating a large % of prepayments to senior tranche could shorten duration, and increase contraction risk (but it reduces credit risk because the senior tranche gets to pocket the prepays first). |
| kodali | Also by having the sub-ordinate tranches still avaialable, they helps senior tranches by absorbing defaults first |