CFA Level 2 - Fixed Income Session 15-Reading 57 Mortgage-Backed Sector of the Bond Market-LOS i (Notes, Practice Questions, Sample Questions) 1. Which of the following statements regarding collateralized mortgage obligations (CMOs) is least accurate: A) CMOs perfectly protect investors against contraction risk but do notprotect against extension risk. [Explanation: CMOs do not perfectly protect investors against contraction risk. They o er some protection against bothcontraction and extension risks, but not perfect protection against either ] B) The Z-tranche or accrual tranche does not receive current interest until theother tranches have been paid o .C) CMOs are securities issued against passthrough securities for which thecash ﬂows have been reallocated to di erent bond classes called tranches 2. Which of the following explains why the companion tranches have the greatest prepayment risk in a CMO structure? The companion tranches: A) are more interest rate sensitive and therefore prepayment risk is higher. B) have to support any principal payments in excess of the scheduledprincipal payments. [Explanation: There is an inverse relationship between the prepayment risk of PAC tranches and the prepayment risk associated withthe support tranches. In other words, the certainty of PAC bond cash ﬂowcomes at the expense of increased risk to the support tranches ] C) consist of underlying mortgages for which prepayment is allowed, asopposed to the PAC tranches 3. Which of the following is least accurate regarding planned amortization class (PAC) versus support tranches? A) The PAC tranches have the greatest prepayment risk in thecollateralized mortgage obligation (CMO) structure. [Explanation: The support tranches have the greatest prepayment risk in the CMO structure, notthe PAC tranches ] B) The prepayment risk protection provided by the support tranches causesthe average life to extend and contract.
C) There is an inverse relationship between the prepayment risk of the PACtranches and the prepayment risk associated with the support tranches