Ali Musa is an alternative investments manager at Venus Capital. He is considering analysing a two franche (a PAC 1 tranche and a support tranche) from a collatelarised mortgage obligation (CMO) that was issued 18 months ago. When the CMO was issued, the initial collar of the PAC tranche was 150-400 PSA. He estimates the change in the average life of each tranche as the prepayment speed varies, assuming the prepayment speed stays at that speed until the tranche matures. The results are as shown in the table:

    

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Average life of tranche XX and tranche YY for varying prepayment speeds: Average Life Note: . . PSA speeds 50 100 150 200 250 300 350 400 Tranche XX 21.9 17.5 13.2 9.1 Required: i. 3.6 2.9 2.0 14 Tranche YY 12.2 8.9 5.1 5.1 5.1 5.1 5.1 4.7 3.9 PSA is the public securities association, a model for analysing mortgage-backed securities PAC is the planned amortization class. Determine the most likely support tranche. Determine the effective collar of PAC 1 Tranche. Average life of tranche XX and tranche YY for varying prepayment speeds: Average Life Note: . . PSA speeds 50 100 150 200 250 300 350 400 Tranche XX 21.9 17.5 13.2 9.1 Required: i. 3.6 2.9 2.0 14 Tranche YY 12.2 8.9 5.1 5.1 5.1 5.1 5.1 4.7 3.9 PSA is the public securities association, a model for analysing mortgage-backed securities PAC is the planned amortization class. Determine the most likely support tranche. Determine the effective collar of PAC 1 Tranche.

Answer rating: 100% (QA)

i To determine the most likely support tranche we look for the tranche with the longest average life In this case Tranche YY has a longer average life compared to Tranche XX for all prepayment speeds ... View the full answer