CMOs LOS 54

CFA Level I Fixed Income
#1

Dear all

I’m having a problem with Los 54. We read in 54d that prepayment risk also means that if prepayments on mortgages are slower we are faced with extension risk and that the contrary, I.e. Contraction risk is more prevalent is seasoned , ie. Older mortgage pools. In 54e however when faced with collateralised mortgage obligations CMOs, they say that the sequential CMOs offer risk distribution in that the short tranche has more protection against extension risk and that the longer ones offers protection against contraction risk .

What I don’t get : this is the longer tranche so why would we have less contraction risk here ?

#2

Because the short (early) tranche is paid off first, there’s less extension risk: the tranche still gets all of its money early.

Because the long (late) tranche is paid off last, there’s less contraction risk: the tranche still has to wait for all of the other tranches to get paid off before it gets paid off.

#3

I still don’t get the second part … can you explain in Greater detail pls ?