Curriculum states that :“the PAC tranche has a stable average life at prepayment rates within the PAC band, all prepayment risk is absorbed by the support tranche for prepayment rates within the band. Even at rates outside the PAC band, prepayment risk is first absorbed by the support tranche”
-I don’t understand PREPAYMENT RATES WITHIN THE PAC BAND . Because PAC has scheduled principal repayments, it doesn’t have any principal prepayments (because support tranche absorbs all principal prepayments)
The PAC has a range of allowable prepayments, say 5% to 15%. If the actual prepayments are within that range, the PAC bonds receive the actual prepayments. If the actual prepayments are below the minimum, the support bonds give up some of their prepayments, which are given to the PAC bonds so that their prepayments are at the minimum. If the actual prepayments are above the maximum, the support bonds receive the excess prepayments.
1 Like
I have an example:
- PAC has a allowable prepayments rate : 5% to 15% corresponding to $10-$15 (monetary amount)
-Question: If prepayment of the collateral is, for example $4, smaller than the minimum prepayment of PAC (i.e., $10), where is the remaining prepayment ($6) which result the prepayment of PAC is at $10? You said that it comes from support bonds which is reasonable?