CFA Practice Question

There are 490 practice questions for this study session.

CFA Practice Question

Select the correct statement(s).

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.
Correct Answer: II and IV

I. The cash flows of a PAC tranche can still vary in the case of extreme changes in prepayment rate.

II. The degree of protection against extension risk increases the shorter of the PSA levels, as the effective collar is wider.

III. Disruption in the schedule of principal repayments of a PAC tranche depends on whether its support tranches have enough room to absorb these extra prepayments.

IV. An extended period over which actual prepayments are below the upper range of the initial PAC collar will result in an increase in the upper range of the effective collar and vice versa.

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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