Principal only strip and PAC tranche

CFA Level II Fixed Income
#1

CFAI mock afternoon question

Q: Does principal-only strip or PAC tranche perform better if interest rates increase and stay that level for some time?

A: PAC tranche performs better.

I thought the answer would be principal only strip as it is not affected by interest rate movement. Can someone explain why answers is PAC?

#2

Principal is impacted by IR movements - decrease in IR -> early prepayment which is beneficial for principal only strip.

If IR increase, obviously the opposite happens.

The IR increase could be within the PAC collar, which means it will ontinue to perform as before (potentially)

#3

Ah…totally forgot about basics…thnx!!