CFA Practice Question

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CFA Practice Question

Which of the following statement is (are) true with respect to CMOs?

I. The prepayment risk faced by each tranche will be different.
II. Some tranches will receive coupon payments while other tranches may only receive an accelerated form of mortgage prepayment.
III. All tranches will receive at all times a payment that is a blend of interest and principal.
IV. Every tranche will have a different average life.
Correct Answer: I and IV

II is incorrect. All tranches will receive some form of coupon. However, some tranches will receive all of the principal repayments that are entitled to before the other tranches begin to receive their principal repayments.

User Contributed Comments 4

User Comment
actiger "II is incorrect because all tranches will receive some form of coupon." - What about Z-bond? I know II doesn't make any sense, but accrual tranche makes the quoted statement false.
NillePet For CMOs there's no Z-bond.
rhardin Actually, for CMO there is a Z-bond (aka accrual tranche). A plain vanilla CMO has 4 tranches, A, B, C, and Z. Z receives no periodic interest until the other tranches are retired. So yes, actiger is correct and II should be incorrect. And the explanation for why II is incorrect does not talk about the Z tranche, and it should.
hks101 Once tranches A, B, C are paid off, Z will receive interest and principal payment from the collateral pool. So it is correct to say that all tranches receive coupon.
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