Don’t quiet get this question, why does "The more the support tranche’s par value rises relative to that of the PAC bond, the better the protection against prepayment risk. " ? Does the par value of support tranche mean support tranche is fully paid off?
Which of the following responses to Preeh’s question about PAC bonds is most accurate? They: A) structure the PAC tranche so it has more contraction risk but less interest-rate risk than the support tranches. B) accrue the interest for one tranche and redistribute it to the support tranches. C) gain prepayment risk protection as their par value falls relative to that of the support tranche. Your answer: C was correct! The PAC tranche has significant protection against prepayment risk at the expense of the support or companion tranches. The more the support tranche’s par value rises relative to that of the PAC bond, the better the protection against prepayment risk. PAC tranches are designed to deal with prepayment risk, and as such pass the contraction or extension risk onto the support tranches. PAC tranches can siphon interest slated for the support tranches, but do not redistribute it. In fact, PAC tranches are designed to provide a minimum guaranteed principal payment by collecting interest targeted for a support tranche when prepayments are low. (Study Session 15, LOS 45.h)