CFA Practice Question

There are 490 practice questions for this study session.

CFA Practice Question

The presence of a shifting interest mechanism ______ for the senior tranche.

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
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